Rafferty Capital Markets’ Richard X. Bove highlights the regulatory impact on Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) in a recent research note.
The regulators have placed relatively high risk weightings on mortgage loans to low income households – i.e., households who have limited down payments, and high principal and interest to income payments (PITI) The regulators have also placed very high risk weightings on mortgage loan securitizations, and mortgage backed securities with low quality mortgages as collateral. They have increased the weightings on mortgages that vary from the standard – e.g., interest only or negative amortization loans.
The so-called “third amendment” to the Treasury agreement with Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) requires that these institutions take their capital down to zero by 2017. The government is also requiring that Fannie Mae and Freddie Mac liquidate the bulk of their mortgage holdings.
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Fannie Mae and Freddie Mac’s loan return policy
Further, Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) have been pursuing a vigorous policy of putting back to loan originators any mortgage with questionable underwriting. This policy has encouraged numbers of private mortgage insurers and holders of mortgage backed securities to do the same.
Affect: These policies have had multiple impacts.
- The change in risk weightings on low income households mortgage requests and the non-conforming mortgages has virtually eliminated low income households from owning homes. The President agrees with this policy and has so stated in a “white paper” written on the subject.
- The policy of putting back questionably underwritten mortgages has dramatically slowed the underwriting process to the extent that it may now take 3 to 6 months to be approved for a mortgage.
- The elimination of Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC)c means the elimination of 20 and 30 year fixed rate mortgages.
This last point requires further illumination. The dozen or so bankers with whom I have discussed this issue are very clear. They will originate 10 to 15 year variable rate mortgages if Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) go. They will not underwrite long-term mortgages and they want nothing to do with fixed rate long term loans in a period when interest rates are at or near record lows.
Therefore, if the standard mortgage document evolves from a 30-year fixed rate document to a 10-year variable or adjustable rate mortgage, monthly payments will go up. If monthly payments go up then housing prices go down. If housing prices fall for all homeowners the equity in their homes drops again and this lowers consumer spending.
Additionally, if the nation no longer is committed to a philosophy of building homes for all of its citizens, then rental housing will and is flourishing. Renters have no incentives to invest in their housing. Neither do landlords. Neither group is committed to the health of their neighborhoods and communities. The nation is, therefore, likely to embark on a policy of ghetto building – the return of multiple Cabrini Greens Housing Developments.