August 10, 2013 in the New York Times
The Housing Market Is Still Missing a Backbone
By GRETCHEN MORGENSON
IN a speech in Phoenix last Tuesday, President Obama finally entered the debate over the future of
United States housing policy. But his talking points offered few details about how to reduce the
government’s giant footprint in the mortgage market.
Mr. Obama vowed to keep mortgage costs affordable for first-time home buyers and working
families, pleasing those who think that the government should have a large role in this arena. His
call for investment in rental housing was a welcome change from past mantras that focused solely
on increasing homeownership across the country.
Playing to taxpayers who are angered by the government’s takeover of Fannie Mae and Freddie
Mac in 2008, Mr. Obama said he wanted to wind these companies down. That’s an important goal.
But as if to prove how hard this will be, both companies later in the week announced enormous
profits for the second quarter of this year, most of which go to the government in the form of
dividends. Together, the companies reported $15 billion in profits; with Treasury on the receiving
end of this lush income stream, it will be tempting to keep the mortgage finance giants in business.
Yet with the government backing or financing nine out of 10 residential mortgages today, it is
crucial to lure back private capital, with no government guarantees, to the home loan market. Mr.
Obama contended that “private lending should be the backbone” of the market, but he provided no
specifics on how to make that happen.
This is a huge, complex problem. In fact, there are many reasons for the reluctance of banks and
private investors to fund residential mortgages without government backing.
For starters, banks have grown accustomed to earning fees for making mortgages that they sell to
Fannie and Freddie. Generating fee income while placing the long-term credit or interest rate risk
on the government’s balance sheet is a win-win for the banks.
A coming shift by the Federal Reserve in its quantitative easing program may also be curbing
banks’ appetite for mortgage loans they keep on their own books. These institutions are hesitant to
make 30-year, fixed-rate loans before the Fed shifts its stance and rates climb. For a bank, the
value of such loans falls when rates rise. This process has already begun — rates on 30-year fixedrate
mortgages were 4.4 percent last week, up from 3.35 percent in early May. This is painful for
banks that actually hold older, lower-rate mortgages.
Private investors, like mutual funds and pension managers, aren’t hurrying back to the residential
mortgage market, either. Deep flaws remain in the mortgage securitization machine, and it needs
to be retooled before investors will begin buying these securities again.
Perhaps the largest problem for investors who might otherwise be willing to return to the mortgage
market is the lack of transparency in privately issued securities. Investors interested in mortgage
instruments are not allowed to analyze the loans going into these pools before they buy them.
The banks putting together the deals typically provide some data, like borrowers’ incomes and
credit scores, as well as whether the loans backed primary residences or second homes. But
investors don’t get access to actual loan files that can tell them what they need to know about the
quality and types of the mortgages packed inside the deals.
A CIVIL case filed by the Justice Department last week against Bank of America highlights the
downside of nondisclosure. In that matter, prosecutors accused the bank of misleading investors
when it sold them a mortgage security in early 2008. Although the bank contended in marketing
materials that the security contained prime loans that met its underwriting standards, more than
40 percent of those loans did not comply with those standards, prosecutors said.
Lawrence Grayson, a Bank of America spokesman, said the bank was fighting the case.
“These were prime mortgages sold to sophisticated investors who had ample access to the
underlying data and we will demonstrate that,” he said in a statement last week.
But the Justice Department contends that the bank failed to disclose important facts to investors
about the quality of the mortgages in the $850 million pool, which wound up performing badly. As
of June 2013, prosecutors said, 15.4 percent of those mortgages had defaulted, indicating that they
were of a far lower quality than advertised. The Justice Department estimates that investors will
lose more than $100 million on the deal.
Then there’s another issue. Investors are also unlikely to take an interest in mortgage securities
because serious conflicts of interest are still embedded in the process.
For example, in the aftermath of the crisis, investors learned that they could not rely on the trustee
banks charged with overseeing these loan pools to do their jobs. The trustees are supposed to make
sure that firms administering the loans treat investors fairly. These duties include taking in and
distributing payments as well as foreclosing on borrowers.
Even though the trustees are supposed to work for investors, these watchdogs are actually hired by
the big banks that not only package the mortgage securities but also provide administrative
services for them. So it was perhaps not surprising that the trustees failed to make the big banks
buy back loans that didn’t meet the quality standards set out when the securities were originally
sold. Such buybacks could have prevented billions in losses for investors, and the trustees’ inaction
indicated where their allegiances lay.
Yet another reason for investors around the country to steer clear of mortgage securities is the
recent action by Richmond, Calif., to seize underwater home loans and reduce the amount of debt
outstanding on the properties. Many of the loans that the city officials want to restructure are held
by mutual funds and pensions.
Pimco and BlackRock, two huge mortgage investors, are among those represented in a lawsuit filed
last week against Richmond, contending that such a plan would violate the contracts that investors
agreed to when they purchased the loans. And the Federal Housing Finance Agency, the overseer of
Fannie and Freddie, has concluded that Richmond’s action could threaten the safety and
soundness of the companies’ operations, harming taxpayers.
Mr. Obama’s views on the path forward for housing finance are welcome. But much work needs to
be done before private capital will come back to this market. Eliminating conflicts of interest and
increasing transparency in the securitization process will go a long way to achieving that end.