FHFA, the GSEs and HAMP

FHFA, the GSEs and HAMP
December 8, 2010
Joshua Rosner


According to a Wall Street Journal story “Fannie Mae and Freddie Mac are in talks with Obama administration officials to join fledgling government programs aimed at reducing loan balances of mortgages where borrowers owe more than their homes are worth, according to people familiar with the situation”. The story is causing much speculation but, in our view, fails to address several key issues.

Firstly, neither Fannie nor Freddie could embark on such a plan without the approval of the GSE’s primary prudential regulator, the Federal Housing Finance Administration (FHFA). FHFA is an independent regulator, chartered by Congress, and is intended to carry out its safety and soundness mandates without political interference. While we believe that Treasury and the White House have repeatedly sought to encourage GSE participation in HAMP, and have likely applied pressure on FHFA toward that end, the regulator has maintained its independence and chosen not to participate in a HAMP principal write-down program. We believe there are several
reasons they have chosen not to participate and continue to believe, even if the Obama administration’s nominee to head FHFA is confirmed, it would be hard for them to choose push the GSEs to participate in the near term.
While Edward DeMarco, the Acting Director of FHFA is a holdover from the Bush administration is likely to be replaced by Obama’s nominee, Joseph A. Smith, the reality is that Joseph Smith will be exposed to the same constraints in this matter. Both Fannie and Freddie are currently held in conservatorship. Under the US Code, as Conservator, FHFA is charged with taking such action as may be “necessary to put the regulated entity in a sound and solvent condition” and “appropriate to carry on the business of the regulated entity and preserve and conserve the assets and property of the regulated entity”. As a result, FHFA may not require the GSEs to participate in any programs, which dissipate their assets or fail to improve the net present value of their assets.
We find it likely that, were the Treasury’s NPV tests shown to improve the net present value of the Enterprises’ assets, the GSEs would already be participating in the HAMP program. As a result, without major and supportable changes to the NPV test, we expect that a new Director of FHFA would be constrained from participation in the same manner that Director DeMarco has been.

Adding to the checks-and-balances that are intended to ensure that FHFA operates in accord with its chartered purpose, and to avoid inappropriate political interference, on September 29th the U.S. Senate confirmed Steve A. Linick as the first Inspector General of the Federal Housing Finance Agency. In his role as Inspector General, Mr. Linik is required to oversee and report to Congress on any waste, fraud or abuse within the regulator and about its compliance with its congressionally mandated purposes and powers. Inspector Linik had clearly stated his intent to “be proactive in overseeing the operations and programs of FHFA, including its management of the conservatorship”. Given his prior work activities1, we expect that Inspector General Linik would not be easily manipulated or pressed to make false determinations about any expansion of GSE activities that may run counter to the conservatorship.

Beyond the aforementioned section of the Federal Code, section 117 of HERA amended the authorizing statutes of each GSE in a manner that empowered the Treasury to purchase the securities of the GSEs’ only if the Treasury meets certain conditions.
These include a requirement that Treasury “protect the taxpayers” by taking into consideration, among other things, “the need for preferences or priorities regarding payments to the Government” and “restrictions on the use of corporate resources”.

Without demonstrable evidence that participation in HAMP would clearly achieve these ends any participation would not be permitted. The stated purpose of the Treasury capital support was to provide monies “necessary to attempt to restore the financial viability of the Enterprises through conservatorship”.
Were the Administration to attempt to place their nominee at FHFA as a means to gain control over the independence of the regulator, and in violation of the stated goals of conservatorship, we expect there would be meaningful backlash from a large number of legislators of both parties. After all, using the GSEs as a means to sop up possible but unrealized mortgage losses would be, in action and effect, an inappropriate use of taxpayer dollars in an un-appropriated manner.
Beyond these constraints, it is our belief that any analysis which seeks to justify a broad program to refinance borrowers who are underwater, but have demonstrated an ability and willingness to pay, based on conjecture of a coming and large wave of “strategic defaults” by that specific subgroup of borrowers, is currently unsupportable and conjectural.

We believe that, given the utility value of housing, most of those borrowers who can afford to make payments on their homes will continue to do so with only secondary regard for their current equity position. Furthermore, based on the defaults we have witnessed so far, most of the “strategic defaults” in the second home and investment property market have already occurred. We believe these already make up a large portion of already accounted for phantom inventory and a considerable amount of foreclosure activity. Moreover, these borrowers are not and were not intended to be included in any of the major government programs and these properties would not qualify. It is important to consider, as we have previously and repeatedly stated, that between 35% and 39% of home sales in 2004-2007 were vacation and investment homes. This is a large portion of current inventory and nobody would support the use of taxpayer dollars to “bail out” these borrowers.

In our view, the biggest obstacle to broader participation in the FHA “short refi” program and in the HAMP program is the unwillingness of the Administration to address the large number of second liens that are currently valued at unsustainably high current values on the books of several large banks. While accounting conventions allow these to be carried as “current” the reality is, if there is no equity in the first mortgage how can there honestly be any value in the second – other than as a retained call option on housing recovery. Perhaps before seeking to use the GSEs’ as a slush fund, Washington might consider first tackling the conflicts inherent in the
servicing of first liens on behalf of MBS certificate holders by servicers who also service second liens on behalf of their own affiliated banks. If servicers were required to either divest the servicing of mortgages in which they have such a conflict or to divest their servicing businesses (which have failed to show any meaningful economies by being integrated anyway), we would expect to see a greater willingness to write down the value of second liens and, as a result, a greater participation in both HAMP and the FHA “short refi” program.

When we have sought to address this with senior policy-makers at the White Housewe have been told, “we have no right or ability to interfere with the workings of an independent prudential financial regulator”. If these worlds hold any truth, we do not expect FHFA to participate in any new or significant manner anytime soon.


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