With a nationwide housing crisis far from over, the risk of future mortgage losses is rapidly shifting from the private sector toward government – and potentially US taxpayers.
This is occurring partly by choice, as policymakers try to stop a wave of foreclosures.
It is also happening by circumstance, as the crisis has left government-linked entities as the lenders of last resort in a troubled marketplace.
One symbol of rising risks came on Tuesday, as mortgage giant Fannie Mae announced a $2.2 billion loss for the year’s first quarter. The Federal National Mortgage Association, the official name that has been shortened to Fannie Mae for convenience, is not officially part of the government.
But its public charter, created in the wake of the Depression, is to help make sure that home loans remain available in bad times as well as good. That mission has helped avoid a total shutdown of mortgage markets over the past year. But it means that Fannie, along with entities with a similar mission, are assuming the risks that come with making loans at a time when house prices continue to fall.
“They are fulfilling their mission ... but concentrating risks on themselves,” Edward DeMarco, deputy director of the Office of Federal Housing Enterprise Oversight, told a conference of mortgage bankers this week in Boston.
Home prices have been falling by double-digit rates in many metro areas, yet the inventory of homes for sale remains sky-high.
The great worry is that, rather than stabilizing, the housing market will spiral downward. Homeowners default in greater numbers when their loan balances exceed the value of their homes. That, in turn, results in more foreclosures and downward pressure on prices.
This explains the pressure on the government-linked enterprises to steady the market.
The House of Representatives appeared poised to vote Wednesday on a bill designed to stem a record tide of foreclosures.
Among other things, the bill would call for the Federal Housing Administration, a government agency, to let cash-strapped homeowners refinance into more affordable, fixed-rate mortgages. Before the FHA agreed to refinance the loans, the current lenders would have to agree to take substantial losses. That means the federal agency would insure a loan that’s smaller than the original one, for about 85 percent of the current value of the home.
The approach might help half a million borrowers keep their homes, according to the Congressional Budget Office. That would help at a time when foreclosures are running at a pace of more than a million a year.
But it would leave the government vulnerable if a high number of borrowers later default on their new, FHA-insured loans. Traditionally, FHA borrowers pay premiums that cover this default risk. Taxpayers might be on the hook in a scenario of high defaults and collateral (property) that falls another 15 percent or more in value after the refinancing.
Fannie and its sibling, Freddie Mac, don’t carry official backstopping by US taxpayers. But they are widely seen as institutions too large and important to be allowed to fail if they ever faced bankruptcy.
Those two enterprises, plus the FHA, have long been titanic forces in housing (see chart). But today they have become even more important. Without them, new credit for home loans would have virtually dried up. That’s because losses on defaulting loans are prompting banks to retrench and investors to stop buying mortgage debts that don’t carry a guarantee from Fannie or Freddie, or FHA insurance.
Rather than holding on to home loans, mortgage lenders sell most of them. In 1995, Fannie and Freddie bought the bulk of those loans and then resold them to investors. At the peak of the real estate boom, other investment firms competed for that business, churning out complicated investments laden with subprime loans, where the bulk of defaults and foreclosures are occurring today. Now that competing business has dried up, leaving Fannie and Freddie accounting for the lion’s share of current activity.
“It’s going to take a long time for volumes to come back” in private mortgage-backed investments, says Timothy Crandall, senior vice president of US Bank Home Mortgage in Minneapolis. For quite a while, he predicts, the reliance on so-called GSEs (government-sponsored enterprises) will continue.
In a bid to ease the housing crisis, politicians are calling on the GSEs to ramp up lending and refinancing activity.
They have authorized Fannie Mae to guarantee “jumbo” loans of up to $730,000 in high-cost markets such as California that are now struggling. And they have criticized Fannie Mae for not following through faster on this mandate.
But regulators and lawmakers also hope to limit the downside risks for taxpayers and for the GSE shareholders.
The Bush administration has argued that it can expand refinancing activity without new legislation such as the FHA program being considered this week in the House. In an effort to keep President Bush from vetoing the bill, Rep. Barney Frank (D) of Massachusetts has moved to package it with other measures supported by the president, such as strengthening regulatory oversight of Fannie and Freddie.
Many analysts say new efforts by Fannie, Freddie, and the FHA need not involve a large taxpayer tab if the process is carefully managed. Still, the risk is significant.
Fannie and Freddie have been moving to raise new capital in order to retain a required cushion as mortgage defaults rise. But some analysts say they have been allowed to operate with capital reserves that are much lower than those of ordinary banks. Between them, the two enterprises have $90 billion in capital, compared with a mortgage business valued at $5 trillion.
Before taxpayers would take any hit, shareholders in Fannie Mae and Freddie Mac stand to lose. Both corporations’ stock-market value has plunged over the past year. Dividend payments have been reduced.
Also, mortgage bankers now have to pay higher fees to channel their loans to the GSEs.
“The cost to us has almost doubled,” says Mr. Crandall.