Raffery Capital Markets Vice President Richard X. Bove maintains a Neutral rating for Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and provides a highlight for Fannie Mae’s recent changes in the fee schedule for loans originating after April 1, 2014 and delivered to Fannie Mae.
Changes in Fannie Mae’s fee schedule
Late Monday, without any public notice, Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) established a new fee schedule for loans originating after April 1, 2014 and delivered to Fannie Mae. The new price schedules are provided on a grid that matches FICO scores to loan-to-value ratios. For example:
- A household with a
- FICO score above 800; and
- A 40% down payment
- Will now pay a 25 basis point fee
- Up from 0% on loans delivered to the GSE.
- Conversely a household with a
- Lower than 620 FICO score; and
- A 3% down payment
- Will now pay a 350 basis point fee
- Up from 325 on loans delivered to the GSE.
This variation in payments makes sense from an underwriting standpoint but effectively prices loans out of reach for low income households.
Of greater interest, the average homeowner might have a FICO score in the 700 to 719 range. S/he may put down 15% to 20% on a new home. The fee if the loan is delivered to Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) was 100 basis points on this loan. It will be 200 basis points after April 1, next year. This is a doubling in the price.
FHFA’s sets loan limits
It is also being suggested by Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA)’s conservator, the Federal Housing Finance Agency (FHFA), that the loan limit for most of the nation’s conforming home loans be decreased to $400,000 from $417,000. Additionally for low LTV homes where the household has a low FICO score, the limit may be cut by as much as 1/3rd to the low $325,000 to $350,000 range.
This change in price is in concert with the overall program announced by the government for Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) when it established its so-called “Third Amendment.” The government is adamant that it wants to leave the housing finance business and is pursuing this goal aggressively.
Governments’ goals for Fannie Mae and Freddie Mac
The governments’ goals for Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) (FMCC/$2.70/NR) have been outlined in three places: a) the President’s white paper on the subject; b) the Corker Warner Bill; and c) the directives from the Federal Housing Finance Agency (FHFA). In broad terms, as indicated, the primary objective is to take the United States government out of the housing finance sector.
This, however, is not easily done because the government over the past 80 years has built a system that subsidizes housing at every level. Some of the methods are as follows:
- FDIC insurance keeps deposit rates at relatively low levels subsidizing mortgage rates.
- The Federal Reserve from time to time aids in keeping rates low.
- At the time of origination government entities like the Federal Housing Administration (FHA) and the Veterans Administration (VA) can guarantee housing payments on selected loans further lowering rates.
- There are direct subsidies to buyers through the Section 8 program.
- There is more than one program to aid homeowners in trouble such HARP and HAMP.
- The government sponsored enterprises (GSE) like Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) borrow money at below market rates for real estate companies due to government backing for their loans.
- There are secondary market programs administered by Ginnie Mae that further subsidize housing costs.
- Moreover, the biggest welfare payment in the United States is the tax deduction one gets for making interest payments on mortgages.
The result of these programs is that homeownership in the United States may be the highest of any country in the world. Moreover, the size and amenities in U.S. housing may not be matched anywhere in the world. Simply stated one might argue that the U.S. citizens are the mots over housed in the history of mankind. In sum, the government subsidy programs have worked beyond anyone’s expectations.
The current system exists because over the past 80 years the government saw housing as the key to resolving a number of issues:
- It reduced social tensions to keep households in their own homes.
- It was a very effective method of stimulating economic activity.
- It created jobs at every level from the builders to the furniture makers to the local movie theaters.
Now, the view in Washington has changed. The government sees housing as a drag on the economy preventing investment in non-construction sectors; and as the destabilizing force that caused the financial crisis. Thus, the three thrusts, noted above, to reverse direction.
- The President wants affordable housing but he does not believe that it must be through homeownership. He apparently favors programs that stimulate rental housing.
- Corker/Warner simply want the GSEs eliminated and the U.S. to leave the housing finance industry.
- The FHFA is implementing a program that will achieve the President and Corker/Warner goals.
FHFA and Treasury’s key programs for Fannie Mae
It is recognized that the key to separating the government from housing is to eliminate the GSEs. To do this the FHFA working with the Treasury has three key programs in place:
- Force a reduction in the size of the mortgage holdings of Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC).
- Take the capital in both companies down to zero.
- Raise the prices of their services so that these companies become non-competitive in the mortgage markets.
It is quite likely that these programs will be very successful. They will get the government out and at the same time reduce the size of the housing market. This is because without the GSEs no financial institutions are likely to make 20 or 30 year fixed rate mortgages. These documents are the lynch pins of the housing market. Without them the monthly cost of housing rises and the demand for housing plummets as does housing prices. The United States moves from a subsidized housing market to a non-subsidized market.
Consequences of the key program
The key to this program working, however, is not whether Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) are eliminated or not. The key is what happens in the economy if these entities disappear. The government’s view is that more funds will be directed to the productive side of the economy and the dislocations in the financial markets caused by housing subsidies will be eliminated. Moreover the private sector will easily replace the government in providing affordable mortgages to households wanting to buy homes.
Ideally, one cannot argue with the government’s goals. Housing prices and housing activity should not be a function of government subsidies. No industry should rely on the government for its success as housing often does.
Disengaging wealth of all U.S homeowners
The question is therefore how does the United States get from Point A to Point B without causing severe harm to the economy and the wealth of all U.S homeowners?
- The first answer to this question is very slowly. One cannot move rapidly from a totally subsidized market to one that is totally free market in nature.
- The second answer is to understand what may happen in the markets that will facilitate or impede the shift to free market activity.
- The third answer is that there must be a sector or sectors of the economy to replace the stimulus provided by housing.
Unfortunately, it appears that the government’s moves out of housing are schizophrenic on one hand and totally in conflict with the three issues mentioned above. The schizophrenia is derived from the fact that while the government is trying to shut down the GSEs and their subsidy impacts on the economy, the Federal Reserve has been in an absolute frenzy to use housing as it has been used in the past. It is buying the largest amount of mortgages ever acquired by a governmental entity to stimulate housing and it is driving interest rates down to an unsustainable level on mortgage debt. The tapering program will not change either of these developments. Stated more simply:
- The FHFA is forcing the GSEs to sell mortgages. The Fed is buying them.
- The FHFA is adjusting mortgage pricing as noted at the outset of this comment. The Fed is promising to keep interest rates at historic lows until who knows what target is reached (the employment target is clearly a moving object).
Characteristically the government has done no studies to determine if its policies will work or not. It shoots out rules and regulations somewhat like an old Gatling gun without having any idea where the bullets will land. It never, never, never commissions or has done any objective studies to determine who its bullets are aiding or who they are killing.
- Problem one is that the government is moving too rapidly. It is likely to destabilize housing prices as a result.
- Problem two is that the simplest of studies would clearly indicate that no banks are likely to replace the government in the mortgage markets.
- They will not make 20 to 30 year fixed rate mortgages.
- They cannot provide loans to low income households; the government is preventing that with its rules and regulations.
- To date no industry or industries have reached the point where they can replace housing’s impact on the overall economy – although energy and medical care might do so at some future point.
Solution for Fannie Mae and Freddie mac
The solution to the problems highlighted here is not complicated at all. Simply return Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) to their previous status and over a longer period force their capital and liquidity requirements higher so that ultimately they can stand on their own without any government backing. In this fashion they will recognized for being what they are—i.e., real estate finance companies. It could happen if rule makers realize where they are driving the economy with their current policies. Pushing mortgage rates higher as is now the case with the price hikes noted above does not get anyone anywhere.