Richard X. Bove, Vice President Equity Research at Rafferty Capital Markets, highlights FHA’s unexpected regulation and how Fannie Mae and Freddie Mac shrunk their capital to zero.
Fannie Mae – Who is the FHA?
The Federal Housing Administration (FHA) is currently a division of the Housing and Urban Development Department (HUD). It was established in 1934 to stimulate banks to originate 20-year fixed rate mortgages. Up to that point the most common mortgages in the United States were like today’s Canadian mortgages. They had 3 to 5 year maturities with balloon payments at the end of the term.
During the Depression homeowners could not make the balloon payments so they defaulted. Banks were so small they could not find the money to help households roll over their mortgage debt even with the help of a government program called the Homeowner’s Loan Act.
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So the government suggested that surviving banks begin to write self-amortizing 20-year fixed rate mortgages. The banks had no desire to do this so the government created the FHA to insure these loans in the hopes that banks would then be incented to write the new loans.
Since that time the FHA claims to have insured 34 million mortgages. Up to 1970, FHA-insured mortgages dominated the industry. They became less dominant after that period due to new innovations in the housing market and the unusually low rate of defaults in the housing sector.
Fannie Mae – Unexpected Deregulation
During the housing crisis the FHA lost the confidence of the banking industry for two reasons:
- It reneged on making good on its insurance obligations, and
- It sued the banks for faulty underwriting procedures.
The banks responded to this treatment by backing away from doing business with the FHA. Today press reports indicate that JPMorgan originated 340 FHA mortgages in the second quarter of 2015 compared to 19,111 in the second quarter of 2014. The bank’s market share of this business fell from 12.2% to 0.2%. Apparently Wells Fargo, Bank of America, BB&T, Fifth Third, and M&T Bank have followed JPMorgan’s lead – although numbers for those banks were not published.
The net result is that mortgage bankers have picked up their originations of these loans just as they did during the Depression. These companies are mostly unregulated. In addition they have a tendency to close their doors when bad times come so that there is no ability to penalize them if they have underwritten faulty credits.
In sum, by excessively regulating the FHA mortgage market, the government has
- Forced regulated companies to back away from the FHA sector, while
- Giving control of this business to companies that simply cannot be held accountable for what they underwrite.
The FHA market has been deregulated.
Fannie Mae – Associated Issues
Since the FHA market is oriented toward assisting low income households in obtaining housing, by cutting off the access to bank funding, on a de facto basis, the government has eliminated access to what was the largest pool of funds for this purpose in the private sector. Apparently the government’s solution to these issues is to warn the banks that they are now going to be fined for redlining – i.e., the practice of not lending money in low income neighborhoods.
Hudson City Bank (HCBK/$9.54/NR) was fined $27 million, 5 days ago, for redlining by the Department of Justice and the Consumer Financial Protection Bureau (CFPB). In the press reports concerning the event, government officials indicated that there would be more fines of this nature.
This sets up an interesting problem because the CFPB’s qualified mortgage rules (QMR) require 20% down payments and 43% payment to income ratios. Banks that do not adhere to these rules are open to major fines and lawsuits from the government and the borrower.
The QMRs effectively redline. Thus, banks will be penalized if they make low income mortgages that do not qualify under the QMRs and they will be fined if they do not make low income home loans.
To make this farce even more poignant, if a non QMR mortgage is bought by a government sponsored agency (GSE) it automatically becomes a QMR. However, Fannie Mae and Freddie Mac were told to stop buying mortgages and shrink their capital down to zero (I am not making this up).
Fannie Mae – Conclusion
The conflicting government rules have created serious issues for the home mortgage markets. It is a factor in slowing the growth of housing activity despite increasing demands for new units.