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David Dayen: A Revealing Episode in DC Groupthink

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By David Dayen, a lapsed blogger, now a freelance writer based in Los Angeles, CA. Follow him on Twitter @ddayen

So this week I got an education in the mentality of “official” Washington.

Last week I was asked by a DC-based publication to give a comment on Corker-Warner, the flavor-of-the-month proposal to abolish Fannie and Freddie and reform mortgage finance. I basically take the same position as Yves on this issue: all of these GSE 2.0 plans assume a private label MBS market the way the proverbial economist on a desert island assumes a can opener. So off I went to write that up. Consistent with the typically frustrating pace of back-and-forth editing, this went through several drafts, refining my general point (which you will see below). So some effort was put to this purpose.

On the day I expected this to run, I get an email saying that the piece was rejected. The same individual who requested the piece in the first place did the rejecting. And I think I need to go through the nature of the complaint to give you a sense of this:

The whole point of the guarantee structure created by Corker-Warner is to lure investors and private capital back into the market by insuring them against losses. The fact that there IS no explicit government “wrap” right now is why private capital has abandoned the market (or at least that’s the CW)!

Note the blind faith in the pronouncements of, I assume, the Very Serious People, and the resistance to anything that deviates from the party line. I guess this is not allowed in certain circles, but I don’t agree with the CW. Private capital has abandoned the market because they were abused, routinely, and in fact are still being abused (you’ll see in the piece below I note the petty theft from servicers, who continue to collect fees on mortgages that have been paid off, to say nothing of foreclosing on homes where the loans could be modified, at a loss to the investor). The insurance in question is actually re-insurance, and it doesn’t kick in until private mortgage insurers take losses they will in all likelihood not be able to handle. So we’d just replace bailing out Fannie and Freddie with bailing out PMIs, and with so much reticence to do so among the officialdom, investors would be correct to wonder whether they’ll be left holding the bag. As for making a clearly implicit government wrap explicit, that’s all well and good but it’s a distinction without a difference.

As I mentioned before, the criticism from the left and the right is that Corker-Warner is too generous toward investors, not that it’s not generous enough (as David asserts).

Oh, OK, so there’s only one type of criticism allowed. A fine publication you’ve got there. And it’s not about generosity, by the way. It’s about a meaningful layer of protection so investors aren’t sent to the securitization markets like cows to an abbatoir. The problem is that Corker and Warner are trying to preserve a market that shouldn’t be preserved.

If he wants to argue (UNRELATED to corker-warner) that the securitization process is still screwed up and deserves more attention than the problem of getting private capital back into the market, that might be fine. But he also has to acknowledge what’s happening with QRM and QM and the reforms that are already underway.

These things are not unrelated. The securitization process is screwed up and that’s the MAIN REASON private capital won’t return to the market (at least not at a level sufficient to replace Fannie and Freddie). As for QRM and QM, it’s fine to talk about origination reforms – which if you think about it, are an argument for banks holding these “safe” loans on their books – but the servicing reforms are far more important in this context, and so far, regulators haven’t dealt with the warped compensation incentives which favor foreclosures over modifications. This harms investors on a daily basis, and while at some level you can’t help people who won’t help themselves, investors have voted with their feet, by walking away from private label MBS.

If you ask me for a piece about housing, you should be fairly confident about what you’re going to get. I don’t know what this individual expected. But the fact that they objected mostly to my daring to diverge with the conventional wisdom shows the box in which the establishment media-political complex willingly locks themselves. At the end of the day, it’s their publication, and they can publish whatever they want. But I can also show you the piece right here and let you decide for yourselves. So here goes it:

Housing Finance Is Still Broken, and the Corker-Warner Bill to Abolish Fannie and Freddie Won’t Fix It

Last week, Congressman Mel Watt appeared before the Senate Banking Committee at his confirmation hearing for Director of the Federal Housing Finance Agency, conservator for the two government-sponsored entities (GSEs). At the same time, two members of that committee introduced legislation to eliminate the job Watt seeks. Republican Bob Corker and Democrat Mark Warner authored a bill to shut down Fannie and Freddie, replacing them with a contraption that fulfills a virtually identical role. But Corker-Warner, like practically every GSE 2.0 proposal, is irrelevant to the core problems with mortgage finance. Indeed, nobody in Washington has shown any interest in designing a system in which private investors might actually want to participate.

Senators Corker and Warner can give you the full details of their plan themselves. But to briefly review, Fannie and Freddie provide liquidity to the mortgage market by buying mortgages directly and bundling them into mortgage-backed securities (MBS). Lenders can use the proceeds from the sales to reinvest in more lending, expanding opportunity for homeownership.

Corker-Warner would scrap both agencies within five years, and end the purchases and securitizations, but would create a Federal Mortgage Insurance Corporation (FMIC) to re-insure MBS above the first 10% of private losses, and cover costs with fees imposed on the issuers. But Fannie and Freddie currently assume the credit risk on the loans they purchase, for which lenders pay a “guarantee fee”. So there’s little difference between lenders paying Fannie and Freddie a fee to assume the risk, or paying the FMIC a fee to insure the risk. Indeed, private mortgage insurers already take a first loss position on most GSE loans they insure, so even that detail is largely the same.

But all this is all rather beside the point. The big problem with the assumptions embedded in Corker-Warner can be seen in this line from the Reuters writeup: “the bill would require (emphasis mine) private entities to buy mortgages from lenders and issue them to investors as securities.”

But nobody is going to buy these securities, for two reasons. First, the private MBS market is rotten to the bone. This is why Fannie and Freddie now own or guarantee 9 out of 10 residential mortgages in America. Private investors lost world-historical amounts of money on these kinds of MBS, often because they were deceived about the quality of the underlying loans. Not a week goes by without some group of investors – be they private firms or public pension funds or mortgage insurance companies or even other banks – suing the issuers of MBS for falsely dealing them loans that did not meet prescribed underwriting guidelines. The settlement payouts to investors in these cases have typically been pennies on the dollar, and insufficient to cover the losses.

In the ensuing years since the crash, while financial reform has touched on regulating the origination and servicing of mortgages, pretty much no effort has been put into cleaning up securitization. This isn’t for lack of trying, either. The Federal Deposit Insurance Corporation proposed a serious plan in February 2010, which would have incorporated several tough investor protections. Issuers would have had to hold mortgages 12 months before they could be securitized; the originator would have retained 5% of the credit risk in the loans; compensation to servicers from investors would have included incentives to modify loans over foreclosure; full disclosure would have been mandated on all sides of the transaction (no more selling to investors with one hand and shorting the security with the other); and re-securitizations like CDOs would have been banned. This would have fixed most of the problems with securitizations. Originators would have had the incentive to make good loans and servicers would have had the incentive to manage them well; the likelihood of dirty dealing would have been massively reduced; and excluding derivatives would have stopped the magnification of losses upon losses in a crisis. Investors would happily have returned to a market that included these features.

You can probably guess what happened next. The “sell side” of the industry, the big bank issuers of MBS, killed the proposal. This made investors leery of purchasing mortgage bonds on the private market; the sell side was basically telling them that they wanted to retain the capacity to screw them over. (Would you play poker with someone who insisted on using a marked deck?) And with banks unwilling to just hold more mortgages on their balance sheets like they did in decades past, Fannie Mae and Freddie Mac are left as the mortgage finance engine of last resort. There have been practically no private mortgage-backed securities issued since late 2007.

Even today, we’re still learning exciting new ways that unscrupulous actors use securitization to fleece private investors. Reuters reported last month that a review of monthly reports made to investors shows that mortgage servicers, who are hired by investors to collect monthly mortgage payments and handle loan modifications or foreclosures, “are reporting individual houses are still in foreclosure long after they have been sold to new buyers or the underlying mortgages have been paid off.” With the home still shown as in foreclosure, the servicer continues to collect multiple fees from the investors (one case shows Bank of America collecting a $50 monthly servicing fee from investors for a loan that was paid off two years ago).

This further means that the bonds carry billions of dollars in mortgage losses that haven’t yet been realized, meaning the true value of these securities is far lower than market pricing. One mortgage bond recently realized $1 billion in latent losses, and more are coming (as much as $300 billion, by one estimate). Essentially, the servicers are still ripping off investors, this time with dodgy accounting. And Corker-Warner would not protect investors from such petty thievery.

Needless to say, nobody has gone to jail for any of these activities.

Corker-Warner claims to protect the MBS investor from being completely cleaned out by putting a backstop on private mortgage insurance losses above 10%. But private mortgage insurers, an industry that has seen notable failures, should not be expected to handle losses of that magnitude in a crisis. Instead of bailing out Fannie and Freddie, the government will have to bail out the insurers. And if they don’t, investors won’t be able to recoup insurance on the bonds, and will take a bath.

So whom exactly do Corker and Warner expect to purchase these products? The same investors who have been endlessly defrauded and abused for their purchases for the past several years, in a market that has seen no reforms? Or a new band of dupes, blithely offering up their capital to be stolen?

Banks love securitization because it’s cheaper for them than holding loans on their books, and having to pay for them in equity capital and FDIC insurance. But those requirements are precisely what make a market safe and fair. They are buffers against risk, which in securitization gets transferred to investors. The market proved incapable before and during the crisis of properly pricing that risk, and now everyone knows it. So the investors are wisely staying away. And if these markets no longer work, then perhaps it’s time to rethink the wisdom of the 30-year fixed rate mortgage (which most other countries don’t have) and come up with a way for lenders to retain the risk while still protecting themselves against catastrophe.

In any case, we can dream up alternatives to a government-financed mortgage system all day, but as long as private investors get fleeced by everyone else in the housing finance system with relative impunity they’re going to stay far away from that market. Especially since the government seems more than willing to pick up the slack. I know Fannie and Freddie are required to wind themselves down as part of the 2008 conservatorship. But with them both earning windfall profits these days (government-backed monopolies tend to do that), I’d say that the shareholders buying up Fannie and Freddie stock, hoping that the government will ultimately punt and recapitalize the two mortgage giants, have made a better bet than anyone putting money down on the viability of Corker-Warner.

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29 comments

  1. diptherio

    Copy Edit:

    I guess this is not allowed in certain circles, but I don’t agree with the CW. Note the blind faith in the pronouncements of, I assume, the Very Serious People, and the resistance to anything that deviates from the party line. I guess this is not allowed in certain circles, but I don’t agree with the CW.

    1. nonclassical

      “..the problem is the securitization process..” (says it all, Mr. Glass, Mr. Steagal)

  2. Aaron

    CW sounds just like the 40,000-foot solution you would get from an administration and Congress that is all about improving the optics rather than the underlying fraud. Why bother fixing the real problem and creating transparent markets, when you can just re-label the product and backstop the losses from a different angle? Surely the problem couldn’t be that we have covered up a vast assortment of securities fraud and other crimes creating hundreds of billions in losses for investors. We just need a new name for our product, something that resonates with the people and evokes a feeling of confidence and truthiness. If it sounds like it will turn a profit, all the better.

    1. dejavuagain

      It seems that the 30 years of attempting to have mortage backed securities look like bonds with guaranteed cash flows is just not going to work.

      How it makes sense for independent servicers to guarantee cash flows on defaulted mortgages and slow-paying mortgages is beyond my little mind. This is the root defect in the structure.

      The investor is to spread its risk by purchasing MBS with diversified well-undewritten pools and MBS from multiple issuers and originators.

      The whole mortgage insurance concept and assured cash flow is a product of business school, if that, inexperienced or greedy operators.

      Let the investor take the risk and rid the market of the evil middleman servicers who claim to do more than service mortgages.

      Instead of paying .5% to mortgage insurers, let the same sum go into a sinking fund to pay for increased costs of managing defaulted mortgages … etc. etc.

      Eliminate the first amendment shield of the rating agencies.

      The IRS should enforce the trust laws.

      MERS should be made illegal – jurisdictions with inefficiently responsive recording systems will just face the political cost of denying mortgages to their citizens until they fix the problems.

      Require auditing underwriting my the issuers, accounting firms, and attorneys and abolish raw theoretical opinions.

      ….

  3. bob

    Just the slight framing of this issue drives me nuts. Why does the government need to attract investors into a market?

    The “reason” F&F were created was to allow 30 year mortgages. Banks won’t lend over 5 years.

    So, F&F were set up to be the “buyer” of last resort for mortgages from BANKS.

    If a bank got into trouble and needed to sell one of its mortgages to raise capital, they could get a “bid” from F&F, assuming that when the mortgage was issued it was to F&F standards. Banks didn’t make many non-F&F complaint mortgages because they might get stuck with them. As long as they held to F&F standards, they would always have a buyer.

    F&F were a “bailout”. They would buy what a bank, or several banks needed to get rid of. F&F would then take the mortgages, bundle them together, and sell an MBS.

    This was not ever meant to be an “industry”. It was meant to solve a very small problem with banks who were in trouble. It worked very well for a while. Banks held most of the risk most of the time, and only sold to F&F what they had to to balance out their books.

    Some of the larger banks, and then later pension funds/hedge funds/rich guys would buy these MBS as long term investments. It turned into a good way to pick up a decent, locked in 30 year yield. This is where things went wrong. Any jerk with a few million could step in and buy a ton of “government guaranteed” paper. He then could sell it the next day if he wanted. Enter the cult of “traders”.

    As for a “solution” to F&F’s money “problems”– It’s been stated a thousand times. Have F&F charge more. But, again, this doesn’t fit into the free market narrative. “government can’t charge more! They are the sucker necessary to make this whole rube-Goldberg contraption operate! It’s anti-capitalist to not have a government mandated and insured sucker in the middle!”

    1. Susan the other

      Interesting. So what is the impact of the Fed buying up all the MBS from the big banks and just keeping them on Fed books till they run off? If the Fed stops this will the banks have any business model left?

      1. MaroonBulldog

        I’ve been wondering about that, too. Does the Fed have an “allowance for doubtful accounts” on its balance sheet and a “bad debt” expense on its P&L? If these “assets” have a notional 30 year life, and the Fed were to write off 3.33% per year, would anyone notice? Or care?

        1. psychohistorian

          You don’t seem to understand that the Fed is “owned” by the same plutocrats that own those private banks.

          They only want to carry debt like the Maiden Lanes at the Fed until they can inflate the value to pre loss prices.

          And Susan the other, yes, the banks don’t want to go back to being utilities anymore than the telcom industry wants to manage bit pipes……so marketing and sales were developed to create fake value.

      2. bob

        The 30 year thing isn’t really accurate. In another “good” piece of american banking, people can pay off mortgages early.

        That’s not the case everywhere.

        Most mortages today aren’t “there” for more than 10 years. Yves would know the number better, closer to 7 years?. They get refinanced, or paid off early.

        The 30 year mortgages is an “option” to pay it off over 30 years. In other places and times, if you were able to borrow for 10 years, you were not allowed to pay the loan back early, or without making good on the remainder of the “interest” payments.

        For instance, If you wanted to pay back a 5 year loan after the first year, you would have to “pay back” the 4 years of interest that didn’t accrue.

        Pre-pay “risk” is one of the things that f&F have to spend a lot of time managing.

        If rates are now moving up…this could all change.

        The fed “buying” MBS isn’t sinister, necessarily. As the bank of banks, they would end up on the hook for them anyway. In other words, even before the fed “buys” the MBS, the fed owns it.

        1. skippy

          Elasticity in the multivariate-verse is problematic… to model… eh.

          skippy… especially when its detached from the baseline… cough… orb.

  4. Capital One asked to pay for the sins of Chevy Chase Bank

    At the very bottom of all this is people on the street. Can’t be repeated often enough.

  5. cjames

    Yeah, speaky the truth in terms considered less than polite, or without presenting sufficient benefit-of-the-doubt to the banks and the authors of the bill, you’re barred. I would LOVE to know which publication it was. Censorship at it’s most American media-ish. Don’t let people know anything resembling the truth! That, above all else, is the CW. I probably know less about the market and the nuances of finance than anyone commenting, but i know enough to trust DD, even more so if the piece was rejected. Lord save us from the CW, on every critical issue facing this country. There’s a reckoning coming, eventually, and it ain’t gonna be pretty.

  6. F. Beard

    Banks love securitization because it’s cheaper for them than holding loans on their books, and having to pay for them in equity capital and FDIC insurance. But those requirements are precisely what make a market safe and fair. David Dayen

    If FDIC rates were “fair” then why wouldn’t private insurers be adequate? Because the implicit backing of the Fed is also needed? So FDIC rates are not “fair”, because they “buy” protection that no premium could, the unlimited backing of the Fed.

  7. NotTimothyGeithner

    I see your problem. I can’t speak for Corker, but Mark Warner is a very serious, middle of the road, pro-business Democrat. Your article suggest here would make it seem that Mark Warner doesn’t any clue about anything which would be absurd because he is very serious and wears a tie.

    1. Tokai Tuna

      Mark Warner is a very serious Banksta. While the exodus of 20 million plus folks from their former living quarters over the years is filled with pain, anguish, financial ruin and rage. Govmint isn’t even measuring accurately the precise number, we’re always told “it’s not so bad”, “you aren’t really in a war zone here in the USA”, and “others have it much worse” so stoically buck up and pull your suitcases out of storage.

      Mr Warner made sure we weren’t going to allow underwater victims to escape their dreams-become-torture chambers in 2009, the Obama Administration, Geithner et al notwithstanding. Wall Street saw the threat of fairness, ie Bankruptcy protections and made sure the debt slaves and victims couldn’t escape the boot on their throats.

  8. Thomas

    What system do you think will work if: the crooked individual Bankers, Wall Street brokers, rating agencies, Brokers, agents, appraisers, etc. all lie, cheat and steal again. They are still out there. Mr. Holder assured that. What “insurance” will make the investors feel like they can put their feet back into the water when they know the sharks are still there and still in control of Washington?

  9. armchair

    As someone who loves to read, I have always been amazed at how difficult it is to read ‘important’ D.C. publications. I would have an easier time reading a 500 page history book than reading a 30 page Foreign Affairs article. I say that because I have never finished a Foreign Affairs article. I mean never. I guess DDay is unwilling to twist up his writing, obscure his points and lead with ponderous introductions about nothing at all. Why, you might actullay learn something from reading DDay. Tsk, tsk.

  10. Dana Shitbank

    Another criticism is the imprecise definition of “the left”, a very popular word in the writer’s toolbox that lacks any precise definition. We’re supposed to assume that “the left” is concerned about what exactly? Fairness? Rich hating?

    Housing remains too expensice, the role of a public GSE should not be to help people “score or get rich” primarily, but to actually assist in making affordable housing available to those that need it.

  11. JDM

    The bit I love is that while other people’s objections are “criticisms”, yours are just something you “assert”.

    I criticize, you assert. I win.

  12. Chris of Stumptown

    @Dave Dayen

    What is the source of the prediction of $300B of forthcoming mortgage bond losses?

    Thanks in advance.

  13. scraping_by

    One thing about the private insurance welfare queen substitute. It allows for more direct transfer of public funds into private pockets. F&F have a little more friction before the cash gets to the operators. Organization and obligations and that sort of thing. Private can go all sorts of opaque and all sorts of bonus-heavy.

    With the rotting away of middle class incomes, the last source of income for the FIRE segment is the Federal Treasury.

  14. Craazyman

    Whoa this is bad.

    But look on the bright side Mr. Dayen, if the DC twits did print this the peanut gallery probly never would have read it. I know I wouldn’t have read it since i would never read anything published in DC except the wash post Redskins coverage.

    and who would you rather have as readers, a bunch of DC twits who think a press release is a form of journalism or the esteemed and exemplary intellects of the peanut gallery? Sometimes bad luck is good luck! It just takes a while for the flower of fortune to bloom

  15. Laocoon

    Getting rid of Fan and Fred does little to solve the problem given the current context. 1) There are other government programs that back housing, what about them? 2) If people had jobs, they’d be paying their mortgages, building equity, etc., and we wouldn’t be having this conversation. 3) Likewise, if new building continued, there would be jobs there also.

    “It’s the jobs, stupid,” to paraphrase. People with jobs have a stake in the value of their home, although now their faith is deeply shaken. Likewise, without jobs, labor mobility is sharply limited. As labor mobility is limited, people don’t move and don’t retire [don't DARE retire].

    Corker-Warner [like many things Corker does] sounds great but falls deeply short of solving anything.

  16. MaroonBulldog

    David Dayen says, “The problem is that Corker and Warner are trying to preserve a market that shouldn’t be preserved.” Amen.

    This legislation seems so corrupt that it will likley pass 98-0 in the Senate and 428-3 in the House.

  17. Carla

    “if these markets no longer work, then perhaps it’s time to rethink the wisdom of the 30-year fixed rate mortgage”

    Some of us remember when a 20-year mortgage, with 20 percent down, was the norm. I believe that many banks (and thrifts) held these loans on their books, and you know what? They didn’t starve.

    It was not called a “fixed rate” then because that’s all there was. If you couldn’t put 20 percent down, you had to pay a higher interest rate and purchase the dreaded private mortgage insurance besides. It’s true, it was another world.

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