Ceding to pressure from consumer groups Fannie Mae eliminated its declining market LTV restrictions policy which required underwriters to restrict loan guidelines by an additional 5% for markets that showed significant price deterioration. Housing Wire has full coverage of the policy reversal. While one might think that protecting the solvency of the nation’s largest buyer of mortgages through appropriate risk management might be prudent the noisy consumer lobby disagrees calling the new policy “redlining” and keeping new homeowners out of the market.
A Risky Proposition
Fannie is over-exposing itself through the reversal of this policy. By essentially ignoring market price declines Fannie is saying that they don’t need solid collateral for loans in certain deteriorating markets. A bad risk policy if you ask me, and one that could have dangerous consequences.
A sound risk management policy requires that underwriting guidelines are in place to protect the investor from loss. Only by protecting itself from loss is the investor able to remain competitive in the market. By taking on the extra risk Fannie Mae will be forced to “make up for it” somewhere - and that somewhere will be through higher interest rates.
Already at the edge of the cliff
Fannie and Freddie are already at the edge of a cliff. They are undercapitalized, taking massive losses quarter after quarter and are setting themselves up for failure. If Fannie and Freddie fail the US government will orchestrate the largest bail out in the history of the country and it will come at our expense. Schools, social security, health care, etc. will all be forced to the back as our country races to print enough money to save these two critical entities in the mortgage market. It will not be good.
James Lockart, director of the OFHEO pointed out the systemic risk posed by Fannie and Freddie as well:
Fannie Mae and Freddie Mac are “a point of vulnerability for the financial system” because their capital is meager in relation to their mortgage assets and obligations, the companies’ main regulator said.
With that skimpy capital cushion, the government-sponsored companies “could pose significant risk to taxpayers as well as to financial institutions and other investors,” the regulator, James Lockhart, director of the Office of Federal Housing Enterprise Oversight, said at a conference in Chicago.
Fannie and Freddie each have “core” capital equaling less than 2% of the mortgages they own or guarantee. Fannie’s core capital as of March 31 was about $43 billion, and the company has since then raised about $6.5 billion more through sales of common and preferred shares, bringing the total to around $50 billion.
If Fannie were a bank, regulators would require it to hold $135 billion of capital to be considered “well-capitalized,” estimated Karen Petrou, managing partner at research firm Federal Financial Analytics in Washington.
Consumer groups need to wake up
Consumer groups who are clamoring for Fannie and Freddie to take on more need to be aware that their emotional and poorly thought-out arguments for looser underwriting guidelines for homes in distressed markets put the entire country at risk. If they stepped back and took a look at the big picture they’d see that if they let the market self-correct that homes would become (and they are becoming) more affordable, that good buyers would come back in to the market at an appropriate price point and the system would find its footing once again.
By pushing the GSE’s to do too much we take a step closer to the edge of the cliff. And when Fannie or Freddie go - we all go with them. Just say no to reckless lending by our GSEs.
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