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.