Secondary Mortgage
Market Policy
Fannie Mae to QRM
Kevin Park
PLAN 761
September 19, 2012
History of Mortgage Lending
Traditional Bank Lending
e.g., Bailey Building and Loan Association
Mortgage Payments
Borrower
Title
Loan
Bank
Interest
Saver
Deposits
The Secondary Market
Closed residential mortgages or mortgage
securities bought and sold
Mortgage Payments
Servicer
Borrower
Title
Loan
Lender
Investor
Investment
The Concept of a Federal
Mortgage Association
“While we believe that most desirable and effective
governmental control could be obtained through special
Federal charter for a new organization to finance urban real
estate, the prospect of securing legislation is admittedly not a
rosy one…It might be possible to arouse Congressional
sympathy for the poor folk who wish to buy their own hones,
as it was aroused for the poor farmer, but as for improving
urban financing in general it is doubtful if it is possible to give
the subject enough sentimental appeal to overcome and (sic)
double resistance against what is considered government
paternalism on the one hand and against the further
extension of Federal action on the other…
“By making it possible, however, for borrowers everywhere to
obtain money on good security at low rates, it would do all
that can be done to [bring the loan rates of local lenders all
over the country to a uniform level]…It might, in addition,
serve as a central market for the purchase and sale of highgrade mortgages with great benefit to the liquidity of this type
of security…
No doubt such an institution might do much to check the use
of improper or unsafe methods by other lending agencies…It
might take so large a part of the whole field as to crowd out
many weak and questionable concerns…A new institution
would certainly not eliminate from competitions concerns
with which its standard would not allow it to compete.”
John H. Gray and George W. Terborgh. “First Mortgages in Urban Real Estate
Finance.” Brookings Institution 1.2 (1929).
The Great Depression
• Before the 1930s, many homes financed with interestonly, 3- to 15-year mortgages.
• Great Depression exposes credit and liquidity risks of
traditional bank lending.
• National Housing Act of 1934 creates FHA to insure
mortgages for a fee to be paid by borrower.
• Also authorizes FHA to create a government agency to
purchase these federally-insured mortgages— Federal
National Mortgage Association (“Fannie Mae”) chartered
in 1938.
Post-War Era
Banks and thrifts remain dominant form of mortgage
financing for another 40 years.
Share of Home Mortgage Debt Outstanding, 1968
22%
Commercial Banks and Thrifts
2%
Federal Government and GovernmentSponsored Enterprises
5%
Finance Companies and Private-Label Securities
Issuers
71%
Other
Source: Federal Reserve, Flow of Funds
Quasi-Privatization
• Vietnam War and Great Society programs
increases federal government outlays.
• Fannie Mae “privatized” in 1968 to move debt
off budget. Becomes a “governmentsponsored enterprise” (GSE). (“Ginnie Mae”
created to continue buying FHA mortgages).
• Federal Home Loan Mortgage Corporation
(“Freddie Mac”) created in 1970.
Rise of the GSEs
• Fannie and Freddie fill the void left by banks and thrifts
after Savings & Loan Crisis.
• Implicit government guarantee substitutes for explicit
deposit insurance.
Share of Home Mortgage
Debt Outstanding
80%
Share of Home Mortgage Debt Outstanding, 1970-2000
60%
40%
20%
0%
1970
1975
1980
1985
1990
1995
2000
Commercial Banks and Thrifts
Federal Government and Sponsored Agencies
Finance Companies and Private Securities Issuers
Other Mortgage Debt Holders
Source: Federal Reserve, Flow of Funds; Historical Statistics of the United States; National Association of Realtors®; Census Bureau
The GSE Model
• GSEs issue bonds (later mortgage-backed securities) to
raise capital to purchase mortgages.
• Conventional: not government insured (not FHA/VA)
• Conforming: debt-to-income limits, documentation
requirements, maximum loan amount ($417K from
2006-2009).
• Freddie Mac issues first mortgage “pass-through” or
mortgage-backed security (MBS) in 1971. (Fannie Mae
did not issue first MBS until 1981).
• Incorporate credit scoring and automated underwriting (AU)
systems in early 1990s.
Profit!
GSEs retain 35-37% of value of implicit government
subsidy.
Market Capitalization
Source: Financial Crisis Inquiry Commission
Affordable Housing Goals
• Federal Housing Enterprises Financial Safety and Soundness
Act of 1992 creates affordable housing goals:
Low- and Moderate-Income Goal – Individuals earning no more
than the area median income.
Underserved Areas Goal – Individuals residing in lower income
areas (90% of area median income in metropolitan areas), or higher
minority areas (minority share 30% or more and median income no
more than 120% of area median).
Special Affordable Goal – Individuals earning no more than 60% of
area median income or residing in low-income neighborhoods and
earning no more than 80% of area median.
Goal Performance
LMI Affordable Housing Goal
Source: Financial Crisis Inquiry Commission
Accounting Scandal
• Freddie Mac reveals “improper management of
earnings” in 2003.
• Office of Federal Housing Enterprise Oversight (OFHEO,
now FHFA) investigation in 2004 uncovers poor financial
accounting and disclosure.
• Top management in Fannie and Freddie forced out, GSEs
agree to implementation of portfolio limits and increased
capital requirements.
• Increased regulation of GSEs will be very evident in
changes to structure of the U.S. mortgage market at peak
of housing bubble.
Crisis
The Housing Bubble
70
140
68
120
66
100
64
80
62
Price-to-Rent (FHFA)
Price-to-Rent (S&P/Case-Shiller)
Price-to-Income (NAR)
Homeownership Rate
Source: S&P/Case-Shiller National House Price Index; Federal Housing Finance Agency House National House Price Index; National Association of Realtors;
U.S. Bureau of Labor Statistics; U.S. Census Bureau
Homeownership Rate
160
House Prices and Homeownership
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
House Prices (19891Q1=100)
House prices started to exceed “fundamentals” around 2002.
Homeownership rate peaked in 2004. Prices peaked in 2006.
Market Share
Share of Home Mortgage Debt Outstanding, 1968-2008
4.0
60%
3.5
40%
3.0
20%
2.5
0%
1968
2.0
1973
1978
1983
1988
Commercial Banks and Thrifts
Finance Companies and Private Securities Issuers
Median House Price-to-Family Income Ratio
1993
1998
2003
2008
Federal Government and Sponsored Agencies
Other Mortgage Debt Holders
Source: Federal Reserve, Flow of Funds; Historical Statistics of the United States; National Association of Realtors®; Census Bureau
Price-to-Income Ratio
Share of Home Mortgage
Debt Outstanding
80%
Market Share
160
80
140
60
120
GSE New Business
Subprime & Alt-A
Price-Rent Ratio
2010Q4
2009Q4
2008Q4
2007Q4
2006Q4
2005Q4
60
2004Q4
0
2003Q4
80
2002Q4
20
2001Q4
100
2000Q4
40
Price-Rent Index
100
1999Q4
Share of Originations
GSE share of originations was inversely proportional to
subprime lending and house prices.
Notes: House price index is scaled by owners' equivalent rent of residences and indexed to the average of 1987 to
2010 equals 100. Market share calculated as 4-quarter moving totals.
Sources: Inside Mortgage Finance; S&P/Case-Shiller National Home Price Index; Bureau of Labor Statistics
Delinquency
Higher risk loans purchased by GSEs have defaulted at
half the rate of self-denominated subprime loans in
the market.
2010Q4
2010Q3
2010Q2
2010Q1
2009Q4
2009Q3
2009Q2
2009Q1
2008Q4
2008Q3
2008Q2
2008Q1
2007Q4
Subprime
FNMA (FICO<620)
FNMA (LTV>90)
FHA
CRA
2007Q3
35%
30%
25%
20%
15%
10%
5%
0%
Serious Delinquency Rate
Note: CRA delinquency rate taken from a portfolio of CRA loans managed by Self-Help Credit Union.
Sources: Mortgage Bankers Association; Fannie Mae; Center for Community Capital
Role Reversal
GSE purchased of private-label MBS inverted their
traditional role and bypassed quality control.
$1,400
Volume of Mortgage-Related Securities, 1997-2009
$1,200
$1,000
Agency Purchases of PrivateLabel Securities
$800
Total Private-Label Security
Issuance
$600
$400
$200
Source: Federal Housing Finance Agency; Inside Mortgage Finance
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
$0
Conservatorship
September 2008
• Initially driven by write-downs on private-label securities
• Weakness in housing market spreads to single-family
book of business
• 40% of single-family credit losses from Alt-A
Fannie Mae Segment Net Income (Loss)
$10,000
$0
Millions
-$10,000
-$20,000
Single-Family
-$30,000
HCD
-$40,000
Capital Markets
-$50,000
-$60,000
-$70,000
2006
Source: Fannie Mae SEC filings
2007
2008
2009
Bailout
• By the end of 2011, Treasury had invested
$182.7B in GSEs. OMB estimates total investment
of $221B but a cumulative cost of only $28B.
• GSEs were required to pay 10% quarterly
dividend on stock purchases. By the end of 2011,
$36.3B had been paid back to Treasury in
dividends.
– In August 2012, Treasury altered dividend payment
plan to take any and all profits.
“Fiscal Year 2013 Analytical Perspectives.” Office of the Management and Budget
Loan Modifications
• 1.5M GSE loans refinanced to lower rates through
Home Affordable Refinance Program (HARP), including
91K with LTV>125%.
• 508,600 mortgage payments reduced under Home
Affordable Modification Program (HAMP)
• In July 2012, FHFA Acting Director, Ed DeMarco, said
the GSEs would not be allowed to participate in a
principal reduction program under HAMP
– FHFA’s own analysis said the program could save the GSEs
$3.6B and taxpayers $1B
– DeMarco was particularly concerned about strategic
default.
Reps & Warranties
• Fannie and Freddie can force banks to
repurchase loans if reviews find the
underwriting didn’t meet Representations and
Warranties set out in sales contracts.
– GSEs asked lenders to buy back $18.9B in
mortgages in first six months of 2012
– Lenders underwriting even more conservatively
than guidelines require to avoid “put backs”
Reforms
Dodd-Frank Reforms
• Consumer Financial Protection Bureau
• “Qualified Mortgage” ability-to-repay standard
– full documentation, no negative amortization, no
interest only, no balloon, no adjustable interest rates
with fixed terms under 5 years, fee restrictions
• “Qualified Residential Mortgage”
– FHFA: debt-to-income (DTI) ratio 28%/36%, 690 FICO
score, 80% loan-to-value (LTV)
– Non-QRM loans require 5% risk retention
• Excludes purchase of PLS from either the numerator or
denominator in calculating housing goal performance
Dodd-Frank Reforms
Percent 90+ Days Delinquent or
Foreclosed Upon (February 2011)
QRM would have only marginally reduced foreclosure
rate above what QM alone would have accomplished
16
14
12
10
8
6
4
2
0
Loans Foreclosed by Proposed QRM Guidelines
Source: Center for Community Capital
Dodd-Frank Reforms
Percent of Loans Excluded
QRM would exclude large segments of the market
90
80
70
60
50
40
30
20
10
0
Exclusion from the QRM Market
All
Source: Center for Community Capital
White
Black
Hispanic
Asian
Dodd-Frank Reforms
Percent of Loans Excluded
QRM would exclude large segments of the market
100
90
80
70
60
50
40
30
20
10
0
Exclusion from the QRM Market
All
Source: Center for Community Capital
Low
Moderate
Middle
Upper
GSE Reform
• GSEs hold entire credit risk, making non-QRM risk
retention effectively irrelevant
– Officially, “deemed to pass”
• February 2011 Treasury white paper laid out three
options:
1.
2.
3.
Privatized system of housing finance with the government
insurance role limited to FHA/VA assistance for narrowly targeted
groups of borrowers
Privatized system of housing finance with assistance from FHA/VA
for narrowly targeted groups of borrowers and a guarantee
mechanism to scale up during times of crisis
Privatized system of housing finance with FHA/VA assistance for
low- and moderate-income borrowers and catastrophic
reinsurance behind significant private capital.
– e.g., federal reinsurance for private mortgage insurers, but notably private
mortgage insurance is not accounted for in current QRM definition
GSE Reform
• “[S]ignificant operational challenge in designing
and managing an organization that can remain
small during normal economic times, yet has the
capacity to take on much more business quickly
during these times of need.”
– Moral Hazard still an issue
• What to do with existing loan portfolios and
guarantees?
– In addition to changing dividend structure, Treasury
also increased rate at which GSEs must reduce
portfolio holdings from 10% to 15% per year. Total
assets currently stand at $1.4T.
GSE Reform
• Risk-Based Pricing vs. Pooled-Risk Pricing
– Loan-Level Price Adjustments and Adverse Market
Delivery Charges
3.5
3.0
2.5
Mar-08
2.0
Jun-08
1.5
Nov-08
1.0
Apr-09
0.5
Apr-11
0.0
740 or
Higher
720 –
739
700 –
719
680 –
699
660 –
679
Note: LLPAs are for mortgages with loan-to-value ratios between 75.01% and 80.00%.
Source: Fannie Mae
640 –
659
620 –
639
Under
620