In my earlier post on the New Normal in real estate, a commenter took issue with my predictions about the future of the 30-year fixed rate mortgage (among other claims). I thought I would expand on that aspect a bit.
The specific mechanism that I think will be put in place is a change in the mission of Fannie Mae and Freddie Mac (possibly other housing-related agencies, such as FHA, VA, and the state/local housing authorities). I expect that Fannie/Freddie will actually become fully government-chartered entities (as NAR suggests) rather than this weird government-sponsored private companies that provide private rewards at public risk. As a GCE, rather than a GSE, F&F will no longer have profit as its raison d’etre, but the promotion of public policy.
In this case, that public policy is to encourage the development of affordable rental properties across the low and middle-income spectrum, thereby reserving homeownership for the (relatively) wealthy who pose far less credit risk to lenders.
That, to me, spells the end of the 30-year fixed rate mortgage.
Allow me to step you through the argument for why this is likely to happen. (Which is not to say I want this to happen, of course.)
Step One: Transforming Fannie & Freddie
The first step is to take over the private-yet-sorta-public companies, Fannie Mae and Freddie Mac. This is the specific recommendation of NAR, as cited above, and influential people like Bill Gross of PIMCO.
NAR makes strong arguments to nationalize F&F:
Unlike a federal agency, government-chartered organizations are established to be politically independent and often are self-sustaining – not requiring appropriations from Congress. The ability of the entities to focus on their mission (in this case, provide liquidity to the housing market), without the need to chase risky opportunities in order to maximize profit, meets one of the conditions that our members hoped to accomplish.
Moreover, a government-chartered authority removes any ambiguity regarding the government’s participation in the secondary mortgage market. REALTORS® believe that the government backing of this type of structure is required in order to instill confidence in potential investors of the entity’s mortgage-backed securities (MBS). Without the confidence of these investors, the ability of the entity to raise capital for the purpose of providing liquidity to the secondary mortgage market will be limited.
Please note that REALTORS® also believe that the entity should not be operated as if the government / taxpayers are in the first lien position. This new structure should be self-sufficient (need no appropriations), price risk effectively to cover potential losses, and utilize any profits to establish a reserve to alleviate losses that occur in economic down turns – reducing substantial risk to the government and the taxpayer.
As it happens, the political climate may be favorable indeed to this move.
The Democrats, ostensibly the party of the little guy, is more like the party of Wall Street in reality. Check out the political contribution patterns of Goldman Sachs, for example. In 2008, the boys and girls at 85 Broad St. gave to Dems over Republicans on a 3:1 ratio (74% to 26%); in 2006, that was almost 2:1 (61% to 38%). And suddenly, in 2010, it’s 45% to 54% in favor of Republicans? The folks at the DNC are not stupid; they know they can’t afford to piss off Wall Street anymore than they already have.
Wall Street people, like Bill Gross, like Lewis Ranieri, and others favor straight up nationalization of F&F into a single entity that supports the housing market. Let’s use Gross’s term: “Government National Mortgage Association” (which is a joke, you see, because GNMA already exists and is usually called Ginnie Mae.) We’ll return to Wall Street people shortly.
The Republicans, in the meantime, are facing what amounts to an internal civil war between the old-guard Party stalwarts and the Tea Party activists who are aiming to take over the GOP to remake it into the party of strict fiscal responsibility. Insurgent candidates in state after state have been slaying GOP insiders in the 2010 primary season. Rick Scott in Florida is the highest profile victory by insurgents, but by no means the only one. Which means that the GOP politicians have a real interest in at least looking like they are fiscal hawks. Reforming Fannie/Freddie won’t have the same repercussion as say taking over General Motors, because the GOP grassroots already see Fannie/Freddie as government organizations spending taxpayer dollars anyhow.
So I consider the nationalization of Fannie/Freddie to be a done deal. Just a matter of time before we see that happen.
What Happens Next?
The most important distinction is, of course, that as a GCE instead of a GSE, Ginnie Mae (which will now include Fannie & Freddie) will have as its primary goal the promotion of public policy, rather than generation of profits.
What might that public policy be?
Well, as I’ve discussed in some detail, I believe the new housing policy of the United States will be to back away from residential homeownership towards affordable rentals. How will this be effected?
A hint can be found from the Conference on the Future of Housing Finance, organized by the Treasury and HUD, which I’ve written about on AOL Housingwatch. According to a report from HousingWire, one of the participants at the conference, a very important Wall Street figure, pointed the way forward:
There was, however, mention that multi-family GSE CMBS outperform the private sector. Alan Boyce the CEO of Absalon, the Soros venture, extolled the values of the Danish mortgage market. There is no doubt that this market is home to perhaps the most-successful residential mortgage-backed securitization platforms.
On top of that, it’s also fair to say, that in Denmark there are a disproportionate amount of socially-assisted renters and a comparatively onerous tax regime.
So with no one to buy GSE REOs and a demand surge for affordable rentals — against the backdrop of market commentary from invitation-only speakers such as Seidman and Boyce — it is clear exactly where Fannie and Freddie are heading…. And it’s not for the door.
Sources I spoke to on the evening before the conference basically confirm that the GSEs are planning a widespread push into the rental space. In fact, it felt that a solution has already been basically settled on, especially as no representative from either GSE spoke at the Treasury conference. (Emphasis mine)
This emphasis on how the new Ginnie Mae will make a widespread push into the rental space is critical.
Transforming Rental Assistance Initiative
The next piece in the puzzle comes from the little-publicized initiative, called Transforming Rental Assistance, part of the proposed legislation entitled Preservation, Enhancement, and Transformation of Rental Assistance (PETRA). HUD has called TRA a “signature initiative” and its top officers, including Secretary Donovan, have been drumming up support for it.
Now, what does a program by HUD aimed at low-income urban area residents have to do with the 30-year fixed rate mortgage, or with Fannie/Freddie/Ginnie Maes?
The basic way that PETRA works is by creating private financing for public housing, based on Federal support of rental payments to landlords:
First, by leveraging funding from other sources. By opening HUD’s rental programs up to private capital like other housing can access, HUD estimates that PETRA would leverage approximately $27 billion in new resources for the public housing portfolio. Additionally, we estimate that billions more of other public and private resources, including LIHTC, will be leveraged. Indeed, the commitment of city and state governments, the private sector, local not-for-profits, and all the other innovators and partners that have emerged in housing finance recent years will ensure a much broader coalition with a stake in the success of public housing.
Second, PETRA will ensure funding is reliable. The engine that drives capital investment in housing at the scale needed, in a mixed-finance environment, is a reliable, long-term, market-based stream of federal rental assistance. Leveraging $7 billion in the first year and $27 billion if the stock is fully converted will ensure a more reliable funding stream than exists today.
Without getting into too much detail, it appears that the way that PETRA/TRA will work is by authorizing public housing authorities to raise debt or equity financing from private sources (read, Wall Street), and incentivizing the banks and investors to take part by the Federal subsidy (read, guarantee) of rental income.
That is a pretty significant factor for anyone thinking about investing in multifamily property: stability of rental income.
Project-Based Section 8 Program
The final piece of the puzzle is the project-based Section 8 housing voucher program. Unlike the tenant-based voucher, which provides the subsidy to the renter, the project-based voucher provides funding/subsidy directly to the landlord or property owner — including private owners.
In exchange for offering low-income rental units, a developer or a landlord might receive a subsidy from HUD guaranteeing to pay the difference between approved market rents and 30% of the tenant’s income (the cap for HUD-supported renters). So if the comparable market rent is $1,000 a month, and your tenant only makes $2,000 a month, the tenant pays $600 and the government sends you a check for $400.
Put the Pieces Together
So if we assemble all the various pieces, what we can outline is the following scenario:
- Ginnie Mae absorbs Fannie and Freddie.
- PETRA/TRA opens up private financing of public housing, which may include (and if present language does not, will be amended to include) project-based section 8 programs. Wall Street cheers (see above, Alan Boyce) because GSE CMBS outperform the private sector.
- Eligibility for qualifying for Section 8 is raised to include a much larger segment of the middle class — people who would otherwise be first-time homebuyers, but now have the option of paying a maximum of 30% of their income towards housing. That’s a pretty sweet deal for a family of four making $75,000 in some areas where entry-level houses start at $400K.
- Ginnie Mae starts to buy up CMBS (commercial mortgage backed securities) in large quantities, thereby funding multifamily development. This is an exact parallel to how Fannie and Freddie used to finance the residential mortgage market, but with a much smaller universe of borrowers: major developers who are building multifamily properties.
- Private lenders, who would ostensibly be the frontline in the financing of multifamily boom, would want two things: compliance with Ginnie Mae standards (much like how residential mortgages were basically guided by Fannie/Freddie guidelines), and stability of rental income. Well, if you’re a developer, you’re really going to want the income stability that a contract with HUD provides you and your investors. In fact, if you’re not participating in some way, shape, or form with the new Section 8 program, it might be hard to find anyone willing to finance you.
- With so much of Ginnie Mae’s money going towards funding this new boom market for multifamily financing, support for residential mortgages will of course have to suffer. Private lenders read the tea leaves and realize that they won’t be able to sell as many residential mortgages — which, after all, lack the government subsidy of CMBS, and individual families are a much higher credit risk than a multi-billion dollar multifamily developer.
Ergo… farewell 30-year fixed rate mortgages! It was nice knowing you.
Is It Unthinkable?
Quite a few smart folks think that this doomsday scenario is far too overblown. Americans would never stand for it, they say. People would storm Capitol Hill with vats of tar and sacks of feathers.
Three points in response.
First, a couple of years ago, the thought of the Federal government nationalizing General Motors was unthinkable too.
Second, after the housing crash, it is not at all clear that many Americans really have a huge appetite for homeownership. Some of these families were wiped out. The media is playing up this angle in a big way, especially after the July home sales figures showed a 27% decline.
Third, before the New Deal, residential mortgages were often 5-year floating rate loans requiring 50% downpayment. There were no mobs on Capitol Hill then. People still bought houses.
It might not happen soon; the economy is fragile, and the Administration is understandably worried about crashing it with any sudden moves. There are some powerful lobbies against this sort of a thing: NAR, home builders, National Mortgage Bankers Association, construction unions, etc.
But opponents of this web of policy will have a tough time convincing the electorate (remember the Tea Party?) who is tired of hearing about housing crash, foreclosures, and irresponsible borrowers that the thing to do is to preserve the key mechanisms of the housing bubble: Fannie, Freddie, the 30-year low-downpayment fixed rate mortgage, the mortgage interest deduction, etc.
Especially since it will be so difficult for the average voter to even decipher what the actual policy is or means.
This will be a fascinating fall and winter.
-rsh
6 thoughts on “Fannie and Freddie: Into Commercial Real Estate, Out of Residential”
I am, and have been wondering how the current lending environment, and the possible changes you talk about, could mean that owner finance will be needed by many to buy or sell a home. I do see major changes in the lending environment, and was hoping for more substantial signs as to the likely future of housing from the recent housing conference in Washington.I am very interested in what the coming election holds in store for housing policy, the economy and the future of America. All I can say is if you are not registered to vote, please register and vote for the candidate of your choice.
Never going to happen while there is so much single-family REO being held off-market. 3.5% down and low credit requirements from the govt are the only thing that has kept mortgage portfolios from cratering completely. Banks don’t want that.
I would put the line at 800k+ where housing prices are no longer directly coupled to the monthly payment. For the 98% of single-family real estate below that mark, any increase in monthly payment will bring down the value of the property until the payment is back at a comfortable level for the homebuyer’s income. And that is the least of our worries.
Let’s run some numbers on a 400k house, close to the FHA limit, using 3.5% down for 30 years:
Mortgage amount: $386,000
Interest rate: 4.5%
Monthly payment + PMI = 1795 + 160 = $1955 for the first ~10 years (then PMI drops)
Using 30% down, 15 years:
$2141/mo
So factor an immediate housing price drop of 10%, minimum.
Now, let’s look at the real problem: the down payments required. Let’s say that the buyer is in very good shape financially and can put away $2k per month, but doesn’t want to gamble on anything with better than 3% returns (which is still something of a gamble today). For the FHA loan, they need to save $14000. That is basically 7 months of saving. For 30% down, you’re looking at 120k. Hmm. That will take you nearly five years, and I think that my original assumption of $2k savings/mo is rather generous for someone looking at buying a $400k home.
Looking solely at the housing market, you then have two major forces at play: baby boomers downsizing or exiting, and effectively *zero* new money entering for five years. Think about the implications.
Looking at the broader pictures, what slows the economy more than anything? Paying down existing debt. If you’re upside down on a house (that you won’t/can’t walk away from) at 6%, can’t refinance, and can’t get returns anywhere for 6%, what are you going to pay off first? Your mortgage. What’s second on that list of economy-shrinkers? Saving money. No one wants to inject a five year gap in our middle-class spending in addition to crippling residential real estate.
Thanks Zac — comments like yours makes writing this blog so much fun, and educational. 🙂
A couple of points/questions, however. I think you make great points as to why the current policy being contemplated in Washington is not the greatest idea in the world. But I think, at this point, that it’s hard to deny that Washington is contemplating a pretty fundamental change to the housing policy.
You’re right, I think, that any major changes like this would result in housing market getting absolutely clobbered. 10% decline in housing prices/values at a minimum is likely a best-case scenario.
The thing that I wonder about is the single-family REO portfolio being held by banks across the country (indeed, the world). The New York Times today re-floated the idea of massive government refinance of the $1.1 trillion performing non-prime mortgages held in securitized pools. Since I consider the NY Times to be part of the media-governmental industrial complex, I rather think decisionmakers in DC are floating the notion to see what the public’s response might be.
Because I don’t really believe that Washington particularly cares about housing values dropping; indeed, the whole notion of “sustainable homeownership” implies that making housing values drop is sort of the whole point. They’d like to make housing more difficult to purchase and reserved only for those who are in good shape financially so as to avoid a repeat of the current foreclosure crisis. They desperately want to get the government out of the business of financing, insuring, or otherwise involved with residential mortgages, but do it without plunging the entire international finance system into turmoil.
The way I see the entire scheme working out is that the government does want to hammer down the residential housing market, but provide an enormous benefit to the lower/middle class via subsidized rentals, while likely saving Wall Street by a Federal refinance/buyout of existing mortgages (while forcing the lenders to take some writedowns and balance-sheet hits for the non-performing loans), and providing a whole new lucrative market in multifamily housing.
It could even work.
This current government has already socialized healthcare and education. It’s hard to call the financial markets a strictly capitalist free-market enterprise anymore with how heavily the government is involved in every aspect of it. Transportation is mostly socialized now as is. Housing and food are the two basic necessities left, and they are too big a prize for those who want to create social justice and greater equality and so on to ignore.
So here’s a question. You say these policies will never happen. Who is going to stop them? Who will argue against these policies?
-rsh
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