The following is a sequential exchange between Representative Barney Frank (D-MA), Chairman of the House Committee on Financial Services, and yours truly.
For those readers who have already followed along, I have highlighted in bold the initial sentence of the latest exchange so you can simply scroll down and pick up where you left off.
Hopefully this dialog will continue…
January 24, 2008
I'm writing to voice my concern over the recently announced homeowner bailout initiative.
Although the cash refunds and other business investment components of the proposal may qualify as a sound fiscal response to the current economic turmoil, the increasing of the GSE conforming loan limits to $730K is a gross misapplication federal regulatory powers and will continue to perpetuate and even exacerbate the unsustainable conditions that have come about in many of our nation's metro housing markets.
It's important to keep in mind that the majority of the housing bubble conditions occurred in metro areas where the now well known era of dangerously lax lending standards resulted in home prices that are completely disconnected from the basic market fundamentals that guided and regulated affordability for many decades as well as a large cohort of homeowners that cannot afford their homes even under the best conditions.
This is NOT a subprime issue. Understand that "prime" Jumbo homeowners are almost as significantly over-leveraged as the now vilified subprime borrower.
By increasing the conforming loan limits so substantially the federal government is merely perpetuating this unsustainable situation and prohibiting the orderly deflating of the nation's home price bubbles.
If this feature of the proposal is allowed to become law it will unquestionably result in continued speculative behavior and inevitably a harder and more substantial housing price crash in the near future.
March 5, 2008
We disagree on the question of raising the loan limit for Fannie Mae and Freddie Mac. First, I should note that the loan limit does not go to $730K across the board. In fact, the major problem, in my judgment, intellectually as well as economically with the current limit is that it sets one maximum price for the whole country, when in fact house prices vary greatly geographically. If we have a maximum limit for loans that make sense in Nebraska, it cannot be sensible for parts of California, Massachusetts, Illinois and New York. For Massachusetts, the limit will be $516K- hardly a luxury price in much of Massachusetts. I do agree that we should be welcoming some deflation of house prices, but the pace at which this happens is very important, and having a very rapid decline exacerbated by a freeze in the credit markets for houses in the $400K to $516K range seems to me unwise.
I agree that this is not a subprime issue. But it is an issue that was brought about by the subprime crisis, and by an excessive reaction to it. Your assertion that people who own homes in Eastern Massachusetts that are worth between $417K and $516K are as over-leveraged as subprime borrowers is not accurate according to any of the data I've seen.
March 11, 2008
Thank you for responding to my initial protest of the Government Sponsored Enterprise (GSE) conforming loan limit increase provision of the recently enacted economic stimulus package but I would like to respectfully challenge some elements of your response.
First, although under prior regulation the Office of Federal Housing Enterprise Oversight (OFHEO) set $417,000 as the maximum sized loan a GSE could purchase for a single family home located in all states and regions except Alaska, Hawaii, Guam and the U.S. Virgin Islands, your assertion that a single limit poses a regulatory dilemma for the nation’s diverse housing markets is incorrect.
It’s important to remember that this limit was intended not to satisfy a sense of fairness for participants in any particular local housing market but rather to ensure the security of the GSEs and prevent unsafe and unsound practices that would run contrary to their statutory charters.
In states and regions where the prior limit of $417,000 was far greater than the typical median single family home price (i.e. Nebraska in your example) homes would still have to meet basic appraisal and other loan qualifying guidelines (also set out by existing statute) thus prohibiting the wholesale distribution of the maximum principal amount.
In states and regions where the prior limit was less than the typical median home price, the $417,000 combined with a healthy 20% down-payment provided for a significant $520,000 home purchase and homebuyers who needed more would be expected to be of the means not requiring affordable housing assistance.
Keep in mind that, as a basic guide, only 12 of the 145 metro area home markets tracked by the National Association of Realtors (NAR) has EVER recorded median home values in excess of $417,000.
Next, it’s important to consider that under the strict interpretation of prior regulatory guidelines the conforming loan limit should have, in fact, decreased for 2007 and again for 2008 as the Federal Housing Finance Boards (FHFB) national average house price declined on a year-over-year basis for both preceding October results.
In the face of the national price declines though, OFHEO took it upon itself to devise a new and substantially more complex strategy for determining the conforming loan limit that sought to mitigate any potential market instability that could arise from an abrupt decrease.
But even under the new guidelines the limit IS scheduled to decrease for 2009 and in all likelihood will continue to require a downward adjustment as the FHABs October average home price continues to decline.
How does Congress intend on accounting for this phenomenon?
Aside from the folly of maintaining a regulatory guideline that only gets amended up and never down, Congress has created a scenario whereby 125% of a greatly decreased median home price may in fact soon be materially LESS than the original $417,000.
Lastly, what I believe Congress and the President have done by enacting this provision is to introduce a substantial amount of uncertainty into an already wounded and fragile marketplace for agency securities.
Investors in agency securities not only know that the changes that have been enacted are unsound, they are now beginning to recognize the significant credit losses that will inevitably be associated to securities produced under even the prior, more restrictive, regulatory environment.
This recognition of instability has already affected GSE operations resulting in the highest yields on agency securities seen in 22 years thus driving up costs for all home-borrowers.
Although Congressional and Executive mandate apparently provide a dynamic and flexible environment for generating regulatory statute that suits the perceived whim of constituents (particularly in an election year), the “law of unintended consequences” remains largely rigid as it appears now quite clear that the main focus of Congress and the Administration later this year will be the federal bailout of Fannie Mae and Freddie Mac.
P.S. As for $417,000 to $516,000 being suitable for eastern Massachusetts remember that the conforming loan limit was $300,700 in 2000 and $359,650 in 2005 and that GSE loans combined with “piggyback” second liens provided plenty of stimulus for our local market bubble.
Massachusetts is not immune and in fact will undergo substantial socio-economic stress in the coming years as home prices don’t deflate slowly as you suggest but in fact continue to re-price sharply downward.
March 11, 2008
Our biggest difference of opinion is your assumption that raising the limit will expose Fannie Mae and Freddie Mac to greater danger. I think the opposite is the case. I think that their ability to participate at the higher levels will add to their financial security.
With regard to the FHA, the Congressional Budget Office gives us a positive score with a comparable increase in the limit - that is they find that these loans will be repaid at an even higher rate than the other loans that fall below the old limit. And Secretary Paulson was reluctant to allow Fannie and Freddie to keep any of the new loans in their portfolio because he said they would be so profitable that they would want to keep them. As to your assertion that this has produced more uncertainty, the response we have gotten has generally been a positive one from people concerned with housing finance. As to "significant credit losses," you say that they were "associated to securities produced" under the prior environment period. Again, our central difference is your apparent view that increasing the limit will exacerbate this. I think if anything it will have the opposite effect.
I am glad to have your prediction that we will soon be engaged in a "federal bailout of Fannie Mae and Freddie Mac," because I disagree and this will give us some measure of the accuracy of our respective predictions in this regard.
March 13, 2008
Again, thanks for your continued dialog…
I’d like to point out that although my “prediction” of a looming federal bailout of Fannie Mae and Freddie Mac may seem dire, it is in no way based solely on conjecture.
In fact, with the Federal Reserve’s recent announcement of the creation of the Term Securities Lending Facility (TSLF), the initial stages of a bailout have, in a sense, already been set.
The TSLF has been designed specifically as an attempt to break the “logjam” in the residential mortgage backed securities (MBS) market particularly for agency securities which account for roughly 70% of all “stuck” MBS by value.
But this action, although providing the kernel of the concept of “bailout” for the GSEs and their associated securities, likely comes too late to help credit markets that are now experiencing unprecedented stress with firms like Carlyle Capital Corp., unable to refinance its residential MBS, now defaulting on multiples of billions of dollars of debt and, as recently as today, desperately attempting to invoke the more substantial bailout of the “implied guarantee” from the U.S. government.
So, why have these mortgage backed bonds become so illiquid leaving the 20 primary dealers (including Goldman Sachs and Merrill Lynch) unable to sell them to investors and likely thousands of investors unable to rid or refinance them as had been so effortlessly accomplished in the past?
There are two main problems that are working to seriously erode investor confidence and both appear to me to be, unfortunately, not very easily solved.
First, steadily falling home prices are driving a surge in the rate of delinquency and foreclosure of agency mortgages.
This should come as no surprise as Countrywide Financial has been and continues to be Fannie Mae’s largest lender customer and servicer responsible for 28% (up from 26% in FY 2006) of Fannies credit book of business.
In fact, there is a fairly strong correlation between Countrywide’s foreclosure rate per total number of loans and Fannie Mae’s “seriously delinquent” rate (which includes both serious delinquencies and foreclosures) per total number of loans both climbing to roughly 1% as publicized in their most recent respective monthly operational reports.
Countrywide is clearly leading the trend by about two months for foreclosures and with over 7% of its loans now delinquent, the future does not appear very bright.
As we will continue to see in the coming months, the relationship between Fannie Mae and Countrywide defaults is not at all incidental and in the path that Countrywide plows, Fannie will surely follow.
The second and arguably more important problem though has to do with our government’s response to this unprecedented crisis.
I think it’s safe to conclude that one of the more dangerous heights reached during the crescendo of this historic asset-credit bubble is that of our government’s (particularly the federal government’s) eager and acquiescent collaboration with private sector.
How did this brewing debacle, that was so obvious to many including several notable and vocal economists, elude regulatory oversight for so long as to now pose easily the most sever systemic risk to our economy since the Great Depression?
More importantly at this point though, why is the government choosing to bluff its way through the decline, propping up triple-A rated entities that we all know are not worthy, creating super-SIVs and other structures for hiding the severe losses of private financial institutions, slashing the fed funds rate in a series of unprecedented moves directly correlated to Wall Street carping, and passing new legislation that seeks to place additional pressure on battered “linchpin” government entities while simply repeating the same mistaken financial engineering that got us here in the first place?
As the primarily foreign investors who would be buying our agency bonds are watching this debacle unfold, I believe they are rightfully concluding that we have fumbled badly, taking a path that, in many ways, is startlingly similar to the one that Japan took when it grossly mishandled the deflation of its massive asset bubble.
They are shying away from subsidizing our mortgage debt and who could blame them.
As for your representation of what Secretary Paulson believes would be profitable or the response you have gotten from “people concerned with housing finance” I can only say that your posture isn’t consistent with what I would expect from an official that essentially holds a position of regulatory oversight over our financial institutions.
I’m sure Secretary Paulson knows a thing or two about profit and the Mortgage Bankers Association and National Association of Realtors can spin a terrific yarn about the benefits of certain government intervention but what the American people need now is a legitimate government that will work diligently to restore the credibility, soundness and transparency of our financial markets and our economic system in general.