Why We Need Fannie Mae and Freddie Mac, and How to Resurrect Them
The author explains the difficult situation with Fannie Mae and Freddie Mac and how to restore them to their useful place in our financial funding system.
Here’s something you might not believe right now or want to hear, but it’s true: We desperately need Fannie and Freddie, and here’s why:
● They greatly facilitate the flow of mortgage funds that we need in order for this country to continue to provide housing. Keep in mind that the housing industry is the economic backbone of our country.
● Fannie and Freddie created standards and benchmarks that allowed us to “commoditize” mortgage loans so that they could be pooled, packaged, sold, and traded.
● This standardization and commoditization enabled investments in mortgages by entities that previously did not invest in mortgages, thereby greatly facilitating inflows of previously unavailable investment funds into mortgage investments
● Fannie and Freddie stood as reliable funding sources that would buy loans from mortgage originators.
● As a result, prior to the subprime debacle, our country was the undisputed role model for the world in being able to provide quality affordable housing.
● Our Fannie and Freddie-based mortgage financing system worked just fine until Congress encouraged Fannie and Freddie to innovate their way into serious trouble and conservatorship.
Most of you reading this will not have had experience working as a mortgage banker before Fannie and Freddie became so pervasive throughout the mortgage market. In the sixties and seventies, selling a portfolio of loans usually was accomplished on a one-off transaction basis with an established correspondent lender. It was cumbersome, to say the least, and involved a great deal of telephone communications and travel. Even when you made a deal, each investor had its own preferences as to how the loan structures and loan files should look.
Then when Fannie and Freddie grew to the point that they were viable and reliable purchasers of mortgages, the previously cumbersome marketing process was replaced by a short walk to the Telerate machine to see what yield Fannie and Freddie were buying at that day, and then phoning in your sell order. Today, the process is all online.
This was real progress since it streamlined the process of marketing mortgage loans and therefore made it more desirable for a lender to originate more mortgage loans since the lender knew that there was a ready source for the sale of their loan production, enabling the lender to turn over its money faster.
Our financial system needs to get back to the point where mortgage lenders can rely upon Fannie and Freddie as reliable funding sources. Accomplishing this goal can be very simple. What needs to happen is a simple roll-back of underwriting criteria and acceptable loan structures to what they were before the insanity set in years ago.
What Caused the Problems Fannie and Freddie Have Today?
Recently, I wrote an article on the subject of the filing of class action lawsuits against numerous lenders by the State Attorneys General of several states. Allow me to cite for you here a paraphrased excerpt from that article that relates to the current subject of how Fannie and Freddie got to where they are today:
● In this country, we have as one of our overriding economic principles and beliefs the idea that widespread homeownership is universally desirable since it is the financial foundation of virtually all people. (Note: This is why we shouldn’t get nervous when economists point out that we only save a fraction of what people in most other countries save, and they conveniently overlook the fact that our citizens have substantially more in home equity than do the citizens of almost all other countries.)
● Home building and associated economic activities are the backbone of our national economy.
● Our government encourages homeownership and provides many economic opportunities and tax incentives to encourage it.
● Fannie Mae and Freddie Mac were pushed by Congress to expand their lending to less credit-worthy borrowers. (see below)
● Lenders' records are regularly examined by the government to make sure that they are making acceptable levels of loans to a wide range of borrower types.
● Lenders responded to government demands for easier home mortgage credit by developing innovative loan structures that would help more borrowers qualify for a mortgage loan by allowing lower payments up front and higher payments or a balloon payment later on.
● Some of these loan structures carry greater risk, so lenders are justified in charging higher fees and higher interest rates than they would charge for a mortgage loan with less risk.
● While the demands of Congress may have caused mortgage lenders to have varied from their previous underwriting standards, it is also an undisputed truth that many of their mortgage loans that are now in trouble apparently were based upon false information provided to the mortgage lenders by borrowers anxious to become first-time homeowners or to move up to a higher level of housing.
● The development of mortgage loan securitization techniques opened up many huge new sources of funds for investment in mortgage loans, thus facilitating a huge expansion of mortgage lending.
How Fannie and Freddie Got to Where They Are Today?
Let’s look at how we morphed from a mortgage loan industry that made and sold to Fannie and Freddie only quality loans made to responsible borrowers and that had a reasonable chance of being repaid, to the unraveling fiasco that we have today:
● In 1977, the Community Reinvestment Act (“CRA”) was passed to encourage mortgage lenders to make more loans in geographical areas that had a history of low loan originations, primarily due to the inability of the residents in the area to qualify for traditional mortgage loans. Federal examiners periodically check the records of all lenders to make sure that they conform to the requirements of the CRA. This continues up to the present.
● Another watershed moment in the dumbing-down of mortgage loan underwriting standards occurred in 1992 with the passage of the GSE Act, which is officially known as the Federal Housing Enterprises Financial Safety and Soundness Act, that established requirements for Fannie Mae and Freddie Mac (known as “Government Sponsored Entities” or simply “GSE”s) to provide higher volumes of loans to borrowers who would not otherwise qualify for a mortgage loan under the nationwide lending standards followed by virtually all lenders at the time. The GSE Act went into effect in 1993 and encouraged Fannie and Freddie to overlook some common indicators that lenders had used for years to determine that a borrower was a bad credit risk.
● Unfortunately, at the same time that these lower underwriting standards were being pushed on Fannie and Freddie, there were rumblings of the federal government creating a governmental regulator to oversee both GSEs. One of the chief purposes of the governmental regulator would be to make sure that Fannie and Freddie purchased more loans originated to less credit worthy borrowers; so the actual situation was that whether or not Fannie and Freddie were destined to purchase more loans to less credit worthy borrowers was a Hobson’s choice decided for them; so then Fannie’s and Freddie’s only choice became whether or not to simply implement the lower underwriting standards being forced upon them, or fight the decision and have the new lower underwriting standards forced upon them by a new permanent governmental regulator. Fannie and Freddie acquiesced and accepted the lower underwriting standards that were being forced upon them.
● Fannie’s and Freddie’s forced acceptance of the new lower underwriting standards served as a nationwide imprimatur for all mortgage lenders that originated mortgage loans and sold them to Fannie and Freddie (which includes just about all mortgage lenders) that they could lower their standards to conform with the “new normal” standards that had been forced upon Fannie and Freddie.
● And in true cascading fashion, institutional investors that purchased pools of loans and securitized loan packages accepted these new Fannie- and Freddie-blessed investments as the “new normal” and poured their investment funds into these mortgage-based investments, resulting in even more funds available to originate poor quality mortgage loans.
● More investment funds flowing into the purchase of these mortgage loan investments created more demand for housing, which, of course, created more demand for subdivision lots and supporting commercial facilities, resulting in our current glut of all of the above.
It should be clear that Fannie and Freddie did not get to where they are today completely on their own. They had a lot of help in the form of Congress pushing them in the direction of liberalizing their underwriting standards and getting destructively creative with their loan structures.
We still know how to make mortgage loans in this country, and we simply need to clear away all of the illogical distractions that were introduced forcibly over the last sixteen years or so, and restore our mortgage banking funding system to its previous level of successful performance. We can do this. If we do this, we will be rewarded by seeing our mortgage banking funding system provide the funds that we need to reestablish a strong and reliable secondary market system for mortgage loans that can be relied upon by mortgage lenders, mortgage loan borrowers, and institutional investors.
ABOUT THE AUTHOR: Banking and Mortgage Banking Expert Consultant Don Coker
Don Coker provides expert witness and consulting services. Over 490 cases for plaintiffs and defendants nationwide, 117 testimonies in all areas of banking and finance. Listed in the databases of recommended expert witness consultants of both the DRI and the AAJ.
Clients have included numerous individuals, 60 banks, and governmental clients such as the IRS, FDIC.
Employment experience with Citicorp, Ford Credit, and entities that are now JPMorgan Chase Bank, BofA, Regions Financial, and a 2-year stint as a high-level governmental financial institution regulator.
B.A. degree from the University of Alabama. Postgraduate and executive education work at Alabama, the University of Houston, SMU, Spring Hill College, and the Harvard Business School.
Clients in 30 countries for work involving 61 countries. Widely published, often called on by the media. Don Coker serves clients worldwide from his Atlanta metro area office.
Copyright Don Coker
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.