The Wall Street Journal
By: Nick Timiraos
June 20, 2011
A weak start to the spring housing season, which could be underscored later this week by reports on sales of new and previously owned homes, is raising the prospect that the U.S. government will dominate the mortgage market for a long time.
The fragile housing market is complicating Washington's stated goal of dialing back its support after it has reduced stakes in the financial-services and auto industries. The slide in home prices in turn is weighing on the economic recovery, and it threatens to hamper a bipartisan push to unwind the emergency support policymakers enacted three years ago.
Falling prices are eroding consumer confidence and hindering job mobility by leaving millions of borrowers trapped in homes worth less than what they owe. A glut of bank-owned foreclosures has slowed residential construction, damping a major source of job growth. In some markets, the share of buyers paying in cash for homes has hit its highest levels in years, a red flag that prices could fall below "fair value" due to a lack of credit.
Fannie Mae and Freddie Mac, government-sponsored entities intended to foster mortgage lending, face a hard balancing act. They are trying to restore sound lending standards without choking off access to mortgages.
"We're not going to get a recovery in housing until the average borrower can get a mortgage," says Kenneth Rosen, a housing economist at the University of California, Berkeley.
The government took over Fannie and Freddie in 2008 to prop up the housing sector, and taxpayers are on the hook for $138 billion. The government can't walk away from those losses unless it's willing to sacrifice confidence in U.S. investments and risk even bigger losses for the housing market.
Together with the Federal Housing Administration and federal agencies, Fannie and Freddie are behind nine in 10 new mortgages. The firms don't make loans; instead, they buy them from lenders, repackage them for sale to investors as securities, and offer guarantees to make investors whole if borrowers default.
Congress has boosted the size of loans that the firms can buy, making it easier for borrowers in more expensive coastal housing markets to qualify for loans. But those steps have crowded out the private sector, leaving investors with fewer loans to buy and either hold or pool into securities that don't have government guarantees.
The Obama administration and Republican lawmakers have embraced efforts to encourage private investors into the mortgage market by curbing the government's role. Officials want to increase the fees that Fannie and Freddie charge lenders and reduce the maximum loan sizes eligible for government backing. The limits are set to decline modestly at the end of September to roughly $625,500 from the current $729,750 maximum in high-cost areas such as New York and Los Angeles.
But market advantages for government entities are only part of the problem. Stable housing prices, more than anything else, would make it easier for private lending to return.
Moreover, the economics of securitization don't work right now. Interest rates are low and investors are demanding high returns, which mean that mortgage-bond deals have made little if any profit for the firms that arrange them. Tight underwriting standards for "jumbo" mortgages--ones too large for government backing--have prompted banks to keep those relatively safe and profitable loans on their books.
"There's a misunderstanding in the market, an irrational belief that says private capital will emerge" if government-supported mortgage lending looks too expensive, says David Stevens, chief executive of the Mortgage Bankers Association who headed the FHA for two years until March.
Trying to "crowd-in" private money could be dicey if there aren't broader structural changes to rebuild confidence, so investors don't have to price in a hefty "uncertainty premium."
"I'm sort of the champion of private capital, but I'm also not naïve," says Lewis Ranieri, the pioneer of the home-mortgage-bond market. "At this point, it really just doesn't work because we don't have those certain fundamental issues resolved.... The damage done to the institutional and retail investor in this crisis was massive, and it was on many levels."
To be sure, some academics say Fannie and Freddie should more aggressively reduce their role in supporting housing markets and test whether private investors will pick up the slack without substantially shocking housing markets.
Historically, most mortgages that weren't held on bank balance sheets were issued as securities and backed by Fannie, Freddie, or the FHA. During the past decade, investment and mortgage banks jumped in and began issuing their own mortgage-backed securities. These private-label bonds, issued by the likes of Bear Stearns and Countrywide Financial, comprised riskier loans.
Because the banking sector isn't large enough to hold more mortgages without expanding its deposit base, securitization markets are an integral part of any lending expansion. The private-label market seized up four years ago as investors faced big losses on investments that turned out to be far riskier than advertised. Just two new privately issued mortgage-bond deals have come to market since, one in April 2010 and another in February, and both consisted of mortgages to extremely qualified borrowers.
"Investors are on strike," says Joshua Rosner of investment-research firm Graham Fisher & Co. "The very basic blocking and tackling that needs to happen for a private market to come back hasn't been addressed." The mortgage market's paralysis stands in contrast to other securitization markets such as those for credit cards, auto loans and even commercial mortgages where deal volume has rebounded.
Investors are looking for standardized contracts that govern private-label deals, better loan disclosures and easily enforceable provisions to kick back loans that don't meet agreed upon standards. They also want to eliminate conflicts of interest in the collection of loan payments, known as mortgage servicing.
Lawsuits between bond insurers, investors and issuers over the soundness of the underlying mortgages, and disputes over whether ownership of mortgages was properly assigned, further underscore the market breakdown. "There's pretty much nobody that's not being sued," said Ryan Stark, a director at Deutsche Bank Securities, at an industry seminar last month.Regulators have addressed some of those problems with a flurry of rules, but some of them could also complicate a revival.
Policymakers are right to worry over indefinite government stewardship of the mortgage market, which makes laying the foundation for a functioning market all the more pressing. If it's lacking, housing won't exit a destructive cycle: one where prices fall because credit isn't flowing, and where credit doesn't flow because housing is weak.
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