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Industry expert: Government hampers mortgage market

Last month, the American Enterprise Institute (AEI) sponsored a forum on whether the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac should be expanding or contracting their footprint in the mortgage market. Ed Pinto, co-director of AEI's Center on Housing Markets and Finance, spoke with Scotsman Guide News about why he believes the GSEs are doing more harm than good.  

Why do say that some of the activities of Fannie Mae and Freddie Mac are similar to what was seen in pre-recession housing-boom period, just prior to the crash?

edpintoThe short answer is that the same themes that were true back in the late '90s [through 2007] are true today. They are encroaching on primary, private-mortgage insurance business. They are encroaching very heavily in multifamily. They are coming up with lots of new programs that compete with the private sector, and they are using their agency status, government guarantee, all the subsidies that they get, in order to compete with the private sector which, of course, isn’t fair.

The private sector can’t compete with somebody who has those advantages. It is very difficult. And so we see a tremendous number of similarities. Back then, they said we think it is completely consistent to enter into the subprime markets. Well, today, Fannie Mae, Freddie Mac, are serving the high-risk markets with 97 percent LTV [loan-to-value] loans and above, high debt-to-income ratios and weaker credit. Those are high-risk loans, and high-risk loans are subprime loans. They are not prime.

What are some of the moves that you think need to be taken by the new Federal Housing Finance Agency director to scale back the GSEs' footprint?

What the new FHFA director needs to do is basically go back to the same strategic plan that [former Acting FHFA Director] Ed DeMarco had. That plan said we are going to shrink the Fannie/Freddie footprint. We are not going to allow them to do loans over 95 percent [LTV]. We are going to raise their pricing [on guarantee fees] so that they are less of a competitive force. We are going to basically make sure that they get smaller, not bigger. And, in the multifamily space, we are going to limit them to $30 billion a year. They did $140 billion last year between them. Think about it. From the end of 2013, they were doing about $60 billion in multifamily, and last year, they did about $140 billion. The market hasn’t grown that much. Basically, they have taken that business two ways. First, from the private sector, from banks and life insurance companies and other multifamily lenders. And secondly, they have inflated prices needlessly. When you make easy credit easy, then you get a lot of business, and that is what Fannie and Freddie are doing.  

The other things that the new director should do would be to limit their loan limits to the traditional loan limit, the regular conforming limit, and get rid of the high-cost limit, which the director could do under its powers as conservator. No. 2, take them out of the business of doing cash-out refis, which is an inappropriate business for Fannie and Freddie in the first place. These are people who already are homeowners. It does nothing to expand homeownership, and it is dangerous. This is risky business. It was risky last time for them, and it will be risky this time. Third, they should get out of the second-home and investor-loan business, because that business also does nothing for people buying a home for owner occupancy. Fourth, they should get out of the regular rate-term refinance business for the same reason. Those categories — cash-out refi, second homes, investor loans and rate-and-term refinances — last year accounted for about 47 percent of the business. It is a very large chunk of their business. The private sector could absorb this easily. Of course, the housing lobby will scream, but they always do. In reality, this business does nothing to advance homeownership one iota.

Fannie and Freddie do serve a purpose, in that they support affordable-housing initiatives. If not them, who?

Better to not have any [initiatives] than to do what we are doing. We have done a lot of research on this. The reality is that when you are in a seller’s market, and a seller’s market is defined as less-than-six-months inventory of existing homes, and you provide easy credit terms, then you will get higher prices. What the government does is provide a lot of easy credit at the lower end of the market, the bottom roughly 60 percent of the market. The big three are FHA [Federal Housing Administration], and Fannie and Freddie. The government is providing this leverage, saying we are doing it to make housing more affordable. But, the reality is, the dirty little secret is, they are making it more expensive, and they are allowing the people to buy it through higher leverage.

If Fannie and Freddie stop doing multifamily, who will finance affordable rental units?

The people who have been financing them before, banks and life insurance companies. Fannie and Freddie don’t add any value to multifamily full stop. They do nothing to lower rents, not one iota. They haven’t added one unit of supply.

Small lenders say that Fannie and Freddie enable them to stay in business, and are concerned that if they disappear, the mega-banks Chase, Wells Fargo and Bank of America will have a stranglehold on retail and the secondary market, controlling the entire mortgage market top to bottom.

The market share that banks have had has been going down dramatically. The small banks, the non-large banks — we have about 12 large banks that we track and the rest are other banks — have had the biggest drop in share. The reason that their share drop occurs is because they are not willing to move out the risk curve during the boom. This happened to them last time in the late '90s and the aught years. Fannie and Freddie begged them to move out the risk curve, and the small banks refused. Thankfully, they did, because they didn’t get smashed any worse than they did. So, their share went down tremendously. The same thing is happening today for the exact same reason. Fannie and Freddie cannot help themselves. They will move out the risk curve in a boom in the name of affordable housing, driving up house prices and creating risk wherever they go. The banks, small and large, basically look at this and say, "I don’t want to participate in that." So, they voluntarily drop their share. We publish that data every month. You can’t argue with the data.

So, my question for the small banks is this, if during the boom, Fannie and Freddie basically move out the risk curve, cater to the nonbanks and marginalize you and your business, how is that helping you exactly to remain competitive? No. 2, when you have the downturn and Fannie and Freddie inevitably put the loans back to you, even the ones you thought were good, how does that help you exactly? This story that somehow Fannie and Freddie are helping them is not borne out by the facts.

By implication then, you would like to see a mortgage market that has far less nonbank presence?

I would like to see a mortgage market where there is skin in the game. Skin in the game and mortgage bankers generally do not go hand in hand. Somebody who I know very well, a president of Ginnie Mae quite a number of years ago, said, "Ed, you have to understand that mortgage bankers originate what they sell, and sell what they originate." And I will add, they keep no skin in the game.

So, banks have capital and have skin in the game. Credit unions have capital and skin in the game. Private mortgage-backed issuers have capital and skin in the game, along with the private mortgage-backed investors. Private mortgage insurers insuring private conventional loans have skin in the game. Those are skin-in-the-game entities. Mortgage bankers, the fact is, they don’t have skin in the game. Their business model is based on not having much capital. And that is the problem. You have Fannie and Freddie that don’t have much capital. You have FHA that doesn’t have much capital. You have Ginnie Mae that doesn’t have much capital. And the main players are mortgage bankers who don’t have much capital. That is why we see these excessive house-price booms. We are now in the process of the second massive house-price boom in the last 15 to 20 years. The last one started about 20 years ago. We are now six years into the second one. There is a reason for that. The reason is Fannie, Freddie, FHA and mortgage bankers without skin in the game.

What kind of system or end state are you hoping for?

To start with, I don’t call it a system. I call it a market. We want a housing-finance market. We don’t want a housing-finance system. System sounds like something out of the Soviet Union, centrally controlled. That is what Fannie, Freddie, FHA, FHFA, Ginnie Mae, the alphabet soup, is, basically a system. It doesn’t work very well together, because there is not a lot of coordination. But, the one thing that happens is that house prices go up. So, I want a market.


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