Stop Mortgage Investor Bailouts

Tags: fannie, freddie, mortgage, housing, taxpayer, investors, financial, percent, should, industry

It really is frustrating when banks, institutional investors, and hedge funds make money off of taxpayer bailouts of the financial industry. That’s a travesty well worth skipping a week’s worth of showers for. Unfortunately, we cannot roll back time to reverse the TARP bailout.

We can, however, stop a bailout going on right now: taxpayer money flowing through Fannie Mae and Freddie Mac to mortgage investors to ensure they don’t suffer losses from families defaulting on mortgage payments.

Three years ago, Treasury Secretary Hank Paulson coordinated a SWAT-like invasion of Fannie and Freddie’s corporate offices, taking the government-sponsored enterprises (GSE) into federal control. Since then the Federal Housing Finance Agency has been pulling the GSE's strings behind the scenes, and the Treasury Department has used them to funnel $169 billion of taxpayer money to mortgage investors.

Since 40 percent of taxes are paid by the top 1 percent, Occupy Wall Street protestors can be satisfied knowing that at least some of the wealth of the elite has been wasted on this bailout—but since a lot of those getting this money are themselves most likely in at least the top 10 percent, that $169 billion bailout ends up flowing right back to them.

But try putting that on a sign.

These mortgage investors had paid fees to Fannie and Freddie to guarantee payment on the mortgage-backed securities they had invested in, but nowhere in their contracts were they promised that the government itself would step in to cover the guarantees if Fannie and Freddie ran out of money. Nevertheless, that is what the government has done—all under the guise of the need to protect the housing market. (If you’re reading this on a generator-powered MacBook Air in Liberty Square, click here for more details on how this all works.)

Yet it turns out that keeping Fannie and Freddie perpetually in federal conservatorship is hurting the housing market.

The future housing market cannot depend on taxpayer guarantees of financial industry investment in mortgages. But right now Fannie Mae and Freddie Mac are keeping alternative housing finance systems from emerging by monopolizing the mortgage market. In fiscal year 2011, Fannie, Freddie, and the Federal Housing Administration bought or guaranteed 95 percent of new mortgages.

Yes, 95 percent. Every one of those mortgages is backed by taxpayer guarantees.

The reason is because Fannie and Freddie charge way below what private mortgage insurers would demand to insure mortgage investment. And that is basically the point, because if they charged the market rate there wouldn’t be a need for Fannie and Freddie. The idea is that more people will invest in mortgages, making it easier to get a mortgage, if investors can get cheaper guarantees. The nature of the GSEs is to create subsidized risk at the expense of taxpayer funded bailouts.

Here is how out of whack the situation is: Fannie and Freddie currently charge around 0.25 percent of what investors make from buying mortgage-backed securities. The Congressional Budget Office suggests that the GSEs should really be charging 4.4 percent.

That may or may not be good material for a wonky sign, but it is a seriously distorted subsidy for the financial industry. It means that instead of collecting $12.5 billion for investor insurance on the GSE's $5 trillion in mortgage-backed securities, they should have $220 billion. That should inspire some rage among protestors.

The Federal Housing Finance Agency finally hinted last month that it will consider raising the g-fee, but likely no higher than doubling the current rate. Which would mean that the GSEs would still be significantly undercharging the financial industry for a guarantee that the taxpayers will cover their investments.

So what can we do about this? There are lots of proposals for how to dissolve Fannie Mae and Freddie Mac in a responsible way. The best method would be to raise the fee charged for guaranteeing mortgage investments steadily over five years to a level where no one wants to do business with Fannie and Freddie anymore, while at the same time forcing the GSEs to limit their business to smaller and smaller sized mortgages. After all, why should someone buying a $500,000 home need federal financing?

But even if you believe the government should help poor people become homeowners, Fannie Mae and Freddie Mac are a terrible way to do it. Public risk for private profit is not good public policy—which I think is the text on a protestor sign somewhere in lower Manhattan. It is one of the roots of the subprime crisis and subequent financial collapse. At most, subsidies for low-income families should be part of the budget and made transparent for debate—they shouldn't distort financial behavior and bail out risky investment failures.

So why haven’t we done anything about this yet? Again, Fannie and Freddie were taken over three years ago. Both the Bush and Obama administrations have had an opportunity to address the failure of the GSE model. The Treasury Department even issued a White Paper in February this year arguing we do not need Fannie and Freddie to support the American housing industry.

Yet nothing has happened.

The Democrat-led Congress from 2009-2010 talked a lot about the financial crisis and spent a year debating reforms for Wall Street, but in the end passed the Dodd-Frank Act, which left in place the bailout for mortgage investors and tens of billions flowing from taxpayers to the financial industry. The Republicans have now had almost a year to address the GSE failure through their control of the House of Representatives, but aside from a handful of bills passed out of a House subcommittee this year, Congress has chosen to let Fannie and Freddie continue to subsidize mortgage investment risk with taxpayer funded guarantees.

This failure of leadership should inspire an Occupy Washington movement demanding that Fannie and Freddie be dissolved and taxpayer funded bailouts and guarantees for mortgage investors be stopped. We will not have a housing recovery until the GSEs are out of the way.

The Tea Party movement started with CNBC’s Rick Santelli’s rant about taxpayer funded mortgage modifications for delinquent borrowers. Occupy Wall Street can turn its fury on the same issue and possibly inspire our elected leaders to finally have the courage to end the policies that are keeping the American housing market down.

Anthony Randazzo is director of economic research at the Reason Foundation. This article first appeared at

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Tanesha said... Rating: 0   Vote +   Vote -  

Instead of ruining the life long work of conuslets, honest, small business owners,it would be nice if someone might actually attempt to get to the bottom of the real estate valuation problem.Fact: There are corrupt appraisers and loan officers who have colluded for money.Fact: This is an extremely small percentage of appraisers and loan officers.Fact: Every profession has crooks.Fact: By definition, it is impossible to regulate criminals.Fact: The licensing laws (FIRREA) of the late 80 s reduced the barrier of entry into the appraising profession resulting in many more less educated and experienced appraisers.Fact: The licensing led to a reduction in the quality of appraisals and a reduction (adjusted for inflation) in the fee for an appraisal.Fact: Appraisers do face pressure from lenders.Fact: There is different pressure for refinances and purchases.Fact: Cuomo's solution was nonsense and will only make matters worse.With these facts in mind we can discuss the issue in more detail. Ignoring the crooks, which give every industry a bad name, and are way to small of a segment to have any affect on the housing bubble, most lenders are trying their best to provide a service (lend money) to a consumer who wants that service. Way down the list of things loan officers are concerned about is convincing the homeowner to borrow more than they are originally hoping for. Most of the time the loan officer must work extremely hard just to get the minimum amount the borrower seeks, approved. Many times the homeowner is desperate for the loan because it will be used to help pay off consumer loans that are at a much higher interest rate. (Hardly taking advantage of the homeowner). The pressure on the appraiser is a result of the loan officer trying to service his clients the best. Since the loan will be based on the value of the home the lender and homeowner need the highest value possible. Since an appraisal is an educated estimate, there can be a difference of opinion. Most homeowners already have an inflated opinion of the value of their home so it is ironic that they are complaining that their home was appraised to high. I don't think any homeowner would wish that the appraiser was overly conservative thereby not being able to obtain a loan. The appraiser is not getting rich by appraising the home a few percentage points higher than it may be worth so the homeowner can get the loan they wish. They don't get kickbacks the fee is still typically around $350. There are some solutions but this is a minor problem in the big scheme of things.The bigger issue (and where the real story is) is the pressure appraisers face when appraising a home that is under contract. It is an extremely rare case that a potential buyer acting in their own best interest does such a poor job searching for a new home that they are duped into paying significantly more than a home is worth. The market is not perfect, variances do exist. I don't think anyone, the buyer, seller, Realtor, lender wants to cede all of the power to an appraiser. Do you really want an appraiser to be so conservative with value that contracts are constantly being broken by appraisers who feel that their opinion is far superior to the buyer and seller who are both acting in their own interest? I think everyone would agree that the appraiser should ensure that the contract price is reasonable but not be overly influenced by personal taste or minor variations in the market. The pressure comes in the form of additional concessions that are added to the contract price to facilitate the deal. In particular I am referring to seller paid closing cost and down payment assistance. Many times a potential buyer can afford the payment on a mortgage but don't have the cash necessary to pay their own closing cost or the down payment. To facilitate the purchase sellers will agree to pay the buyer's closing cost and sometimes through and intermediary (Nehemiah, Ameridream etc) the buyer's down payment. Of course the homeowner is not doing this for charity (they still expect to net the market value of their home) so his only recourse is to boost the sale price. It then falls upon the appraiser to appraise the home at the new raised contract price. Yes, it would be great if the appraiser could always resist the pressure but there is a considerable amount. Buyers, sellers, Realtors, lenders all want the home to close and the appraiser is the only clog. The appraiser gets nothing more than the typical $350 fee so his only motivation is to continue getting assignments. As noted above the licensing requirements of the late 80 s resulted in so many new appraisers that the fees and competition is tremendous and appraisers are often desperate for any assignments.Instead of attempting to add more regulations to the appraisal process (all have failed miserably and the unintended consequences have made things worse) they should eliminate the source of the pressure, seller concessions. The amazingly simple solution is for Freddie and Fannie to not buy any loans that have any seller paid closing cost or down payment assistance (the new bill recently passed attempts to do away with the down payment assistance). The story is that although everyone want to complain nobody actually wants to solve the problem because it would significantly reduce the number of transactions. Everyone from Fannie and Freddie, banks, Realtors, builders, buyers, sellers, and government all benefit from more homeowners.If government (OFHEO, Fannie, Freddie, etc) wants to continue to allow seller concessions and subsidize homeownership than at least be honest about it and take the pressure off of appraisers who are barely surviving. Why does all of the pressure fall on the appraiser? Why can't an appraiser simply be honest and tell the lender that the home is worth a few thousand less than the contract price and the loan would still be approved? The root lies in the Community Reinvestment Act. In an attempt to eliminate so called red lining Congress overly regulated the lending process to take out any judgement of the loan officer. The result is the only person that can input his opinion is the appraiser which is why there is so much effort to attempt to influence this opinion. Do away with the Community Reinvestment Act and put the pressure of the loan performance where it belongs, on the lender. We have come a long way since the Community Reinvestment Act, no greedy loan officer is not going to do a loan simply because of the color of ones skin.Of course government can never admit their errors that have caused this problem, FIRREA (licensing law) and the Community Reinvestment Act so instead they are adding even more regulations that are so foolish that they have destroyed an entire industry.Andrew Cuomo's solution, the Home Valuation Code of Conduct, has the effect of mandating that each bank or mortgage company use only one appraisal company. Apparently he believes that if he can create a few appraisal companies that have a monopoly on all of the appraisal business (these monopolies are often times called appraisal management companies) that this will somehow result in better appraisals (I wonder if there was any lobbying involved). His thinking is that if a bank uses one company that is so large and burdensome that there will be little chance that their employee, the appraiser, could ever provide service to their client, the lender, which may require some communication between the two. Of course this is not how he would characterize it but it is the affect. The so called Appraisal Management Companies, have convinced him that they are the solution. The truth is that all they do (the may attempt to differentiate themselves) is maintain a list of thousands of appraisers (who they have never met or work they have never viewed) who are willing to work for half of the price of the market based fee of approximately $350 (because these companies have a monopoly). Of course the consumer will still pay the same if not more. The Home Valuation Code of Conduct has put thousands of small appraisal companies out of business. These are the often the most established and professional firms around. The companies that are not easily influenced and that take pride in passing on their knowledge to new appraisers. There is no other industry ever where it has been forbidden for a client to speak to a service provider. This only the beginning of the problem. If you think the lending process is messed up, just wait?

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