The U.S. could be headed for a new mortgage crisis by this summer, believes one analyst. Richard X. Bove, Vice President of Equity Research at Rafferty Capital Markets, said in a report dated March 1 that it’s looking increasingly likely that we will see one. He highlighted how much control the government now has over the nation’s mortgage markets and explained how this could be a recipe for disaster.
U.S. government controls the mortgage markets
Bove pointed out that the U.S. government now insures one-fourth of all new residential mortgage loans and purchases one-sixth of all residential mortgage loans issued. Further, government-sponsored enterprises Fannie May, Freddie Mac and Ginnie Mae own or ensure three-fifths of all current outstanding mortgages in the country, and the problem is getting worse and worse every quarter, he said.
He added that the government continues to increase its direct ownership of the mortgages as well, suggesting that we could see a whole new mortgage crisis characterized by the government getting too deeply entrenched in it.
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Fannie Mae, Freddie Mac rule the roost
Bove notes that Fannie Mae and Freddie Mac together either own or insure 45.9% of the mortgage market right now, amounting to $4.6 trillion in total. In 2009, the two government-sponsored enterprises owned or insured 41.9% of the market. Following Fannie and Freddie is the private sector in terms of size, as he said it controls 38.8% of outstanding mortgages, amounting to $3.9 trillion.
Ginnie Mae is wholly owned by the government, and although it currently sits at the bottom of the mortgage market in terms of size, he said it’s the fastest growing. Currently it holds 15.2% of the market at $1.5 trillion worth of mortgages. In 2009, its share was only 5.7%. In fact, Bove said Ginnie is growing so rapidly that it’s stealing market share not only from the private sector but also from Freddie and Fannie as well.
U.S. government keeps intervening
Further, he said the government keeps intervening in the mortgage payment insurance industry through three main agencies: the Federal Housing Administration, the Department of Veterans Affairs and the Department of Agriculture. The FHA’s share of the market nearly doubled from 2004 to 2015 from 23.6% to 40.6%, and the agency has made sure to keep its iron grip on the market. Bove said that in 2014, its market share started to decline, and then in January 2015, the agency slashed its rates by 50 basis points to gain back the share it lost.
The Department of Veterans Affairs has seen its market share slip slightly over the last 11 years from 23.7% in 2004 to 22.8% last year. Mortgage insurers in the private sector are the ones giving up market share, he added. In 2004, they held a 66.6% share, but by 2015, private insurers’ share of the market had been sliced just about in half to 33.8%. One bright area Bove noted though is that they are beginning to come back after bottoming out at a 14.9% share in 2009.
Insured mortgage payments reach a 100-year high
So exactly how did the government gain such a dominant position in the mortgage industry? For one thing, he noted that in the last mortgage crisis, officials established some programs to help homeowners who were about to default on their loans. Second, he said the government changed the banking rules, causing banks to pull away from mortgage origination.
Third, he said the government pushed mortgages from Freddie and Fannie back to the banks and then started reneging on the guarantees set through the FHA. And fourth, he said it allowed brokers and bankers to steal share from banks in mortgage origination. This last one is a big problem because brokers quickly discovered that the fastest way to get mortgages approved was through the FHA, and then to get it off their balance sheets quickly, they sold them to Ginnie.
A new mortgage crisis sparked by the government’s involvement?
Bove suggests that the current setup with the government dominating the mortgage industry isn’t sustainable. For one thing, it has ruled that Fannie and Freddie must not have any capital by the end of 2017 by taking all of their earnings, plus more, each quarter. This sparked a feud between Fannie and Freddie shareholders and the government as they fought back in an attempt to protect their investments. However, they have been unsuccessful and as a result, both GSEs have essentially become insolvent, said Bove, which contributes to his view that a mortgage crisis could be imminent.
Why does all this point to a possible mortgage crisis in just a few months?
The Rafferty analyst believes the mortgage market is too comfortable with the government’s control despite Fannie’s and Freddie’s insolvency. He said lenders assume that both GSEs’ debt is guaranteed by the government’s credit, but it’s unclear that this is actually true. He added that it’s unclear that the government would even honor the debt if a crisis occurs.
True, the GSEs can draw down money from the U.S. Treasury after their equity runs out, and their respective managements insist that this will protect all that debt. Bove questions whether they will actually be able to borrow from the Treasury, however, even though they have the right to do so, and a mortgage crisis could result.
“What would happen if the politicians heard that the Treasury had bankrupted Fannie Mae and Freddie Mac?” he queried.
He believes that if either of them sought money from the government during election season, it would turn into an “explosive issue.”
“I do not believe that the current Administration could defend its actions in bankrupting both companies or in driving them into insolvency,” he concluded. “The whole government approach to financial stabilization, which is now not trusted because bank stocks are plunging, would be called into question. Time is ticking on the GSE issue because they are totally incapable of meeting their obligations if the country slips into recession – and Mel Watt, the GSE regulator knows it.
“If Fannie and Freddie seek more money from the government, the lynch pin will have been pulled on the government owned mortgage markets. The little boy will have pulled his finger out of the dyke and housing will be inundated.”
Graphs in this article are courtesy Rafferty Capital Markets.