Isn’t Anyone in Washington Paying Attention?

We are all, by now, well aware of the $400 billion travesty created by subprime lending and the fundamental structure of Fannie Mae and Freddie Mac.  A platform which includes private profits and public liabilities should have been conceptualized in a different fashion. In the 1980’s, the government thought an increase in the homeownership rate from 64% to 75% would be positive for the country and incentives were given to these government sponsored enterprises to help achieve that objective. They loosened their standards, expanded their platforms and supported riskier loans (over 20 years later the homeownership rate has only increased 3.4% to its present level of 67.3%).  Subprime lending was a central catalyst for the difficulties faced by Fannie and Freddie as loans were made to people who did not qualify for them. A bubble was created and spectacularly burst when we discovered that housing prices could not keep going up forever. Lesson learned, right? Think again.

Enter the Government National Mortgage Association, aka Ginnie Mae. Ginnie’s mission is to bundle, guarantee and sell mortgages issued by the Federal Housing Administration. The FHA is the government’s in-house mortgage operation which, given the difficulties in the housing and related markets, has grown spectacularly as it filled a void. As the FHA has grown, so has Ginnie Mae. FHA/Ginnie now guarantee $680 billion of mortgage securities, a 400% increase since 2006.

In June alone, Ginnie had issued $43 billion in mortgage backed securities. By the end of next year, it is expected that Ginnie’s mortgage exposure will eclipse the $1 trillion mark. With the activity of late, Ginnie has now swaped positions with Fannie Mae in terms of loan volume.

Here is what is troubling: the government has eased FHA’s already loose underwriting standards while every other lender on the planet has tightened them. FHA’s program and oversight are notoriously lax. It accepts very low downpayments (3.5% generally) and will make loans to borrowers with below average to poor credit ratings. They also have other policies which, among other things, allow borrowers to finance closing costs which can reduce the downpayment to a mere 2%. Given the tremendous growth of the operation, it is even more likely than before that fraud protection mechanisms will be ineffective. This is called subprime lending and Washington is running the show.

Additionally, FHA has been the recipient of a Congressional blessing to assist with the refinancing of hundreds of thousands of subprime and other exotic loans extended to borrowers who can’t (or wont) make their mortgage payments. Through the Home Affordable Modification Program, the FHA will refinance these troubled loans by reducing the balances of the loans by as much as 30%. The stated purpose is to reduce foreclosures but someone has to pick up the tab. Guess who? Right, the US taxpayer.

Fannie Mae and Freddie Mac carried “implicit” government guarantees. (These are off balance sheet liabilities for Uncle Sam which, if reported properly (no one believes the government wont stand behind them), would increase our national debt by 75% to about $12.7 trillion and a more than 90% debt-to-GDP ratio, but questioning the integrity of the National balance sheet is another topic for another post). FHA and Ginnie carry “explicit” guarantees of the government.

HUD’s Inspector General issued a report recently indicating that FHA’s default rate has risen to 7% which is more than double the level considered tollerable for lenders. Moreover, the report found that 13% of the loans were delinquent by more than 30 days. Because of these facts, the FHA’s reserve fund has been reduced by more than 50%,  going from 6.4% to about 3%. Why is a 33 to 1 leverage ratio ringing a bell to me? The report went on to say that, “FHA may need a Congressional appropriation intervention to make up the shortfall.”  It sounds as if yet another bailout is on the horizon.

Doesn’t Congress have a responsibility to the US taxpayer to secure the soundness and safety of FHA? Common sense reforms would show that attention was being paid to the extraordinary things that have occurred recently. Why not increase the downpayment requirement to a level where the borrower has something to lose by defaulting? This would be the best protection against default and foreclosure. Why not participate in the upside of the home’s value given the generous terms upon which loans are made. The “participation” could protect the taxpayer from inevitable losses.  This would allow those who benefit directly from the program to help support the program.

I know that the function of the FHA and Ginnie Mae are fundamentally well intended and necessary. The government needs to provide an overly reasonable path to the “American Dream” for those who need a helping hand. The point is that we were just afforded the opportunity to learn a VERY costly lesson about the dangers of subprime lending. It is a big concern that the lesson has seemingly been missed by those on Capitol Hill and the government is now explictly running the biggest subprime lending operation in the world.

19 Responses to “Isn’t Anyone in Washington Paying Attention?”

  1. 1 JWB August 27, 2009 at 8:54 am

    Congress should be required to take a stake in these decisions through their pension fund.

  2. 2 rknakal August 27, 2009 at 11:56 am

    Hi JWB, Now that would be common sense reform !!

  3. 3 David Terbeek August 28, 2009 at 8:25 am

    This article is right on. We have just shifted subprime lending from one place to another. However, it is hard to expect the same group that caused the issues to solve the issues.

  4. 4 r lobel August 28, 2009 at 9:12 am

    What makes you for one moment think that Congress has a clue about basic economics?

  5. 5 J. Castle August 28, 2009 at 9:18 am

    That just sounds to simple for them to understand. My question is how in the world do you even get the question and the possible solution to them in the first place.
    Why is it big business and associations can email a 1,000 people at the same time to get a message out, yet we the people seem to be only able to email our senators and congress one at a time. Maybe your organization can get something like that done.

  6. 6 wrc August 28, 2009 at 11:30 am

    This issue was not missed by Capital Hill.

    Good financial decisions do not exist in Washington DC anymore.

    All decisions pander to special interest groups.

    People who agree with the positions taken in this piece must have missed the congressional hearings on this very matter where regulators were savaged by members of congress for suggesting what Mr. Knakal cites in his article.

    It was even suggested by congress that it was discrimination to require borrowers to prove they had the financial capability to repay these loans.

    This entire sub prime mess was orchestrated by congress.

    They gutted the regulations that required borrowers to have a significant down payment and prove income, thus creating the culture of the liar loan which has severely damaged our financial system.

    The solution is to elect a whole new group of responsible law makers to replace the band of crooks we now have in Washington.

  7. 7 rknakal August 28, 2009 at 2:12 pm

    Hi David, thanks for your post. Your point is well taken and that is why many people expect significant change to take place during the mid-term elections.

  8. 8 rknakal August 28, 2009 at 2:15 pm

    Hi Robert, thanks for your post. As we were saying on the golf course a few weeks ago (my arms are still tired!) it should be a prerequisite for every elected official to take two introductory economics courses prior to serving. At least then, some of the obvious mistakes would likely not be made. Cheers!

  9. 9 rknakal August 28, 2009 at 2:20 pm

    Hi J, thanks for your post. We have been working very hard on trying to engage with politicians (both en mass and individually) to have them understand the positions which would be beneficial to our industry. Topics have included rent regulation, zoning legislation, affordable housing, taxation and a host of others. The fact is that most of the positions that will help our industry also help general economic development and are in the best interest of most municipalities. We shall keep fighting the fight.

  10. 10 rknakal August 28, 2009 at 2:24 pm

    Hi wrc, thank you for your post. As stated above, the mid-term elections will provide an opportunity for America to speak. The tennor of the town hall meetings on healthcare are indicative of the frustration being felt by many in the country about the irresponsible spending and very deep hole that is being dug for us. November of 2010 will be very intersting.

  11. 11 Carl Todd August 28, 2009 at 6:30 pm

    You know that politicians (not statesmen) only look at the immediate sound bite reaction and if there is perceived benefit of their proposition no matter how small and short termed the alleged benefit may be. If it will create a future problem they’ll worry about it and may try to correct it only if they’re reelected and if not its the other guys problem then not theirs.

    Bill Mhaer was kicked off NBC for holding a mirror up to the face of congress for his quip: “In America we have the best politicians money can buy – and it sure does!”. Of couse NBC being owned by G.E. on of the nation’s largest government contractors could not allow that type of freedom of speach that could possible hurt their main business with if some thin skinned elected officials wanted to keep us dumbed down to believe that they are acting only for the good and welfare of the electorate and are sacrificing themselves by doing their job working for an almost pro-bono wage with no side or future benifts (i.e. becoming a lobyist, or getting a job for themselves or a family member with a government contractor when they leave office).

  12. 12 rknakal August 28, 2009 at 6:45 pm

    Hi Carl, thanks, as always, for your post. I always appreciate the way you sum things up. The system is broken, as you point out. If only doing “the right thing” instead of worrying about being re-elected was the primary objective of our representatives, we would be in much better shape. I hope you are feeling well and that you enjoy the rest of the summer.

  13. 13 Broker August 31, 2009 at 9:18 am

    Terrific piece Robert. It should be required reading for all of parasites that we refer to as “congress” and “senate”. They have taken a horrible program and shifted it from two federally affiliated agencies to another and it doesn’t take much intelligence to see that the end result will be the same. The 2010 elections cannot come too soon.

  14. 14 rknakal August 31, 2009 at 9:44 am

    Hi Broker, thanks for your post. The way Congress should sum it up is: Fool me once, shame on you; Fool me twice shame on me.

  15. 15 ntfeldman August 31, 2009 at 12:10 pm

    Robert, I always appreciate your insight. We are just beginning the “learning” process on this lesson. There are miles to go before this gets better.

    It’s not just an FHA problem, or a congressional problem, it’s not a them and us problem, it’s a we problem. We all share it, we are all a part of the solution, many were part of the problem. It’s great to see people caring about what goes on in Washington again. Greed and complacency got us here, effort, patience and responsibility will get us out. Knee jerk reactions won’t solve the problem and could have unintended consequences that exacerbate the situation. It took the better part of 11 years to grow the economy to it’s most recent peak, expect it will take a cycle out of about the same. It’s just a lot less fun going down than going up.

    The problem is in no way an isolated FHA issue. Affordable home ownership should be achievable, as long as the borrower is truly prepared for the responsibility. Borrower’s “skin in the game” is only one tool of risk/loan assessment. There are today many borrowers who had 10-20% “skin in the game” who have walked their loans. But I caution you against believing that further contracting a buyer pool, already radically contracted, is a viable solution. That would have far reaching implications. We need growth now more than ever before – responsible growth. And your choices are to place the assets into the hands of someone, choose: 1. Institutions, 2. Investors, 3. Home owners. I choose home owners first and investors second, they care more.

    Growth is going to get us out of this mess and it requires “fuel” and that “fuel” is leverage. Borrowing isn’t the problem, the risk assessment of the borrower’s ability to repay needs to be adequately addressed. “Sub-prime” isn’t just about leverage ratios. Standards were relaxed, fraud was incentivized. These played a larger role in the demise of the system than is being revealed and if eliminated would go a long way towards fixing the issues with the new pool of buyers aging into the population every day. Set your watch (7-10 years from now we’ll all be fine).

    Statistically, the back bone of American enterprise is built on the borrowing against a person’s primary residence – this banking crisis effects our economy on so many levels, it’s not just about a place to live. Adjust the risk assessment but don’t eliminate the ability to grow.

    Responsibility should be a requirement of all trust (like loans) and that’s what needs to be incorporated into the changes and reform throughout our financial institutions.

  16. 16 Bonnie August 31, 2009 at 12:18 pm

    if the downpayment is increased you will find many houses NOT getting sold. Not everyone can afford big downpayments and the size of the downpayment does not always determine how good of a homeowner someone will be.

  17. 17 Abe Hedaya September 2, 2009 at 10:51 am

    “You know that politicians (not statesmen) only look at the immediate sound bite reaction and if there is perceived benefit of their proposition no matter how small and short termed the alleged benefit may be. If it will create a future problem they’ll worry about it and may try to correct it only if they’re reelected and if not its the other guys problem then not theirs.”

    Amen, Carl. We shouldn’t expect our politicians to act responsibly when perceived solutions to a crisis carry financial implications that can span decades.

    I don’t understand this country’s aversion to renting, either. Why should the government (and the taxpayers who support it) carry all of the risk in the name of giving people the chance to own a home?

  18. 18 rknakal September 2, 2009 at 7:37 pm

    Hi Abe, thanks for your post. I always enjoy your perspective. You make some very good points and they illustrate why there are so many problems with the system. From the moment most elected officials are elected, they are running for re-election either for the same office they are in or the one they aspire to. This makes legislating properly very challenging.

  19. 19 cheap zometa September 16, 2009 at 12:19 am

    Bob, You are right. I really enjoy your perspective.

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