While the Administration's new Homeowner Affordability and Stability Plan has had press gaggles focused primarily on issues surrounding loan modifications since its announcement earlier this week, the newly-minted HASP faces some tough questions around just how the GSEs expect to manage a refinance program that allows borrowers with an LTV between 80 and 105 percent to refinance into a new loan without additional credit enhancement.

Perhaps the most pertinent issue involves the GSE's own charters, established by Congressional authority; those charters require credit enhancement on any loan purchased or guaranteed by either Fannie Mae (FNM: 0.00 N/A) or Freddie Mac (FRE: 0.00 N/A), when the loan-to-value ratio involved is above 80 percent.

"The charters are most brief, and the language is clear any loan purchase must have either 80% LTV, mortgage insurance, or a 10% risk retention by the loan originator," Jim Vogel, head of agency debt research at FTN Financial in Memphis, Tenn., wrote in a note to clients Friday morning. "So, one broad interpretation might be a refinance is not a purchase even if it files a new lien for a larger principal amount."

More from Vogel: "The charter’s regulatory provisions never contemplated a GSE oversight body as created in 1992 or the all powerful czar formed in July, 2008. In the latest addition to the charter canon, last summer’s HERA, the Director is given oversight of the housing mission “only through activities that are authorized under and consistent with this title and the authorizing statutes (i.e. the charter)” [Section 1102, note and emphasis added]."

For its part, the Federal Housing Finance Agency — that "all powerful czar" Vogel referred to — said Friday in a brief statement that it believes the refinancing initiative fits within the scope of the GSE's existing charters, but did not provide further details.

"FHFA has indicated that Fannie Mae and Freddie Mac Refinance Initiatives to assist homeowners with high current loan-to-value mortgages would be a proper exercise of their existing authorities," the statement said. "The Enterprises intend to provide detailed implementation plans in the near term as the program is rolled out."

The program is set to be rolled out on March 4.

Fannie and Freddie have not responded to requests for comment, and a request for comment to the Mortgage Bankers Association — traditionally a vocal opponent of GSE expansion on behalf of its members — had not been answered by the time this story was published.

It also seems that the FHFA was facing some fury from private mortgage insurers over the suggestion that the GSEs would be allowed to refinance borrowers into higher-LTV loans without the need for credit enhancement on those loans — potentially costing an insurer an existing premium income stream, or new business.

FHFA director James Lockhart responded to those concerns in a letter sent to the Mortgage Insurance Companies of America late Thursday, in which he made it clear that "we intend that the Enterprises would seek to carry forward to the new loan the existing mortgage insurance contract, where applicable."

"At a minimum, this would be at the same dollar coverage and premium as exists with the existing mortgage," Lockhart said. "I encourage MICA member companies to work with Fannie Mae and Freddie Mac to ensure that the existing mortgage insurance coverage carries forward from the old loan to the new loan."

But Lockhart also made it clear that borrowers originally below the 80 percent threshold, but now above that limit, would not be required to obtain mortgage insurance — although he said that "the initiative does not preclude mortgage insurance from being obtained."

If a brouhaha had been brewing, Lockhart's letter clearly seemed to placate at least some concern among MI providers. MICA president Kevin Schnieder said Friday a statement that MICA members appreciated what he characterized as an "important clarification" of the homeowner assistance program.

The question of how the GSEs can manage a refinancing transaction above 80 percent and through to 105 percent without the need for credit enhancement, however, appears to remain an unresolved issue.

"Do you think they tried this fluffy FHFA solution because there are so many other issues around the charter right now?" asked one source, an ABS/MBS analyst that asked to remain anonymous. "I think the manly thing to do is to give Congress the language and tell them to get it done pronto."

Write to Paul Jackson at paul.jackson@housingwire.com.

Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.

Since twin housing finance giants Fannie Mae (FNM: 0.00 N/A) and Freddie Mac (FRE: 0.00 N/A) were placed under conservatorship last year, Federal Housing Finance Agency director James Lockhart has famously (infamously?) intoned that both GSEs now carry an "effective" guarantee on both their debt and mortgage securities.

But "effective" is clearly not the same thing as an explicit guarantee, despite wrangling by U.S. policymakers and other administration officials designed to coax overseas investors back into the agency MBS markets.

At least not in the eyes of the all-important Asian financial markets, where investors have been voting with their pocketbooks for the better part of six months now — and demonstrating beyond pale just how comparatively (in)valuable they really see an "effective" guarantee of GSE bonds to be.

December TIC data, released earlier this week, shows that overseas investors were net sellers of $37.5 billion in agency bonds — including agency MBS — during December, bringing cumulative net selling of agency bonds by overseas investors to $170 billion in the second half of last year. It's no surprise that the Fed has had to step into the agency MBS markets in a big way, then, and has been swimming upstream against softening demand (to steal a phrase from dear colleague Linda Lowell).

According to analysts at Bank of America (BAC: 7.29 -0.14%), Japan and Korea were net sellers of $6.5 billion in agency bonds during December alone, while China was a net seller to the tune of $1.2 billion in Dec. 2008.

Hideo Shimomura, chief fund investor in Tokyo for Mitsubishi UFJ Asset Management Co., told Bloomberg Friday that "there is still a concern that there is no guarantee" of agency debt and securities, even after the Obama administration has said it will sink as much as $400 billion in increased funding to backstop the operations of the GSEs, as part of its Homeowner Affordability and Stability Plan, or HASP.

“Looking at the risk, [GSE bonds are] not so attractive,” he told the news service. “We need a guarantee before we’ll buy.”

Part of that problem is the fact that GSE debt is now effectively competing against debt issued by commercial banks under the Federal Deposit Insurance Corp.'s Temporary Liquidity Guarantee Program; such debt is backed directly by the government, without the nagging questions that inevitably come with divining the real meaning of an "effective" guarantee.

All of which should underscore a big challenge for anyone and everyone in the mortgage market that is yet left standing: the one still-functioning market that is out there is now facing some problems of its own. And those problems go well beyond figuring out how to simply keep mortgage rates for borrowers at a desirable level, although that's certainly part of the equation here.

“Overseas investors are looking for the full-faith-and-credit clarification,” Laurie Goodman, senior managing director at Austin, Texas-based Amherst Securities Group LP, told Bloomberg in an interview. Goodman is a former head of fixed- income research at UBS AG.

But extending such a full-faith and credit guarantee would clearly come with its own dangers — risks that a new Obama administration likely is well aware of as it now weighs its options for mortgages and housing. For one thing, such a move would instantly nearly double the U.S.' debt. And Standard & Poor's Ratings Services has warned as far back as April 2008 that nationalizing the GSEs could come at the cost of the U.S.' own sterling sovereign credit rating.

“We believe [the GSEs] pose large contingent fiscal risks that recent policy decisions aimed at supporting the U.S. mortgage market have made even larger,” S&P analysts wrote in the report last year. “If these risks were to translate into increased government debt, they could even hurt the U.S.’s credit standing.”

In a deep and prolonged recession, S&P had estimated last year that the cost of nationalizing the GSEs, together with loans and guarantees extended by explicitly-guaranteed U.S. government agencies, yielded a potential fiscal cost to the government of up to 10 percent of GDP. At that time, John Chambers, chairman of S&P's sovereign rating committee, sought to diffuse concern by noting that the agency was not predicting a deep or prolonged recession.

Let's just say I'd expect S&P's stance has changed since last April.

But perhaps all the doom-and-gloom sort of concern for the agency MBS market is unwarranted. After all, Freddie was able to complete a record $10 billion, three-year note sale this week — at yields slightly above a similar government-guaranteed issue by JPMorgan Chase & Co. (JPM: 37.21 -0.75%), as Bloomberg notes.

Freddie Mac treasurer Peter Federico used the successful issuance as a chance to suggest that the worry over Asian sell-off of agency bonds is overstated, according to Bloomberg. “There are a couple of institutions who continue to sell agency debt,” he told the news agency. “I think their reasoning for doing that is not related to their comfort with our credit."

But Asian investors purchased only 12 percent of the issue, with the rest going to North American buyers — and does anyone feel like betting on just who from North America was busy picking up the majority of the new bonds?

Write to Paul Jackson at paul.jackson@housingwire.com.

Disclosure: The author held various put option contracts on JPM when this story was published, and held no other relevant investment positions. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.

Investors are starting to figure out that "too big to fail" might just end up meaning "all your deposits and assets belong to the government," if Friday morning's trading activity in equity markets is any indication. Front and center in the most recent dust-up on Wall Street is none other than The Bank of Amerillwide — at least, that's the moniker DealBreaker's Bess Levin has taken to using for Bank of America (BAC: 7.29 -0.14%), and we sort of like it over here at HousingWire.

The Wall Street Journal reported Friday morning that BofA CEO Ken Lewis was issued a subpoena by New York State Attorney General Andrew Cuomo, over issues surrounding the bank's acquisition of Merrill Lynch. Cuomo is attempting to discern if investors were misled at the end of 2008 regarding the depth of bad assets on the books at Merrill, and whether details of the bonus payments should have been disclosed to investors.

Market chatter and rumors HW has heard have suggested for weeks that BofA's own board was surprised by how many bad assets appeared on Merrill's books after the rushed acquisition (and the assumedly pressed due diligence process that went with it); if there is any truth to the rumors, it may be difficult to suggest that BofA deliberately misled investors.

Nonetheless, both BofA and fellow banking giant Citigroup, Inc. (C: 30.87 +1.61%) saw their stock prices tank early Friday as investors fretted over the potential nationalization of both entities. "We see no reason to nationalize a bank that is profitable, well capitalized and actively lending," Scott Silvestri, a spokesman at Bank of America, told MarketWatch. A Citi spokeman echoed similar logic to the news service.

The Journal also reported that Lewis was put on the defensive Thursday during a senior leadership meeting, citing an unnamed source, and told company officials that policymakers in Washington have assured the BofA CEO that nationalization is not an option currently being considered.

Shares in Bank of America were at $3.23, down 17.81 percent, when this story was published. Shares in Citigroup were off 20.32 percent, at $2.00.

Analysts have speculated for week on the possibility of nationalization for some or all of the U.S. banking system. “I think nationalization makes an awful lot of sense,” Walker Todd, a former Federal Reserve official now with American Institute for Economic Research, told CNBC in an interview Friday. “Not only is it a viable alternative to keep going with TARP or bad bank solutions, eventually you reach the point where the money needed surpasses the capacity of the taxpayer.”

And while policymakers have told BofA's Lewis that nationalization is not on the table, other press statements from policymakers seem to contradict that sort of sentiment

“The tolerance for throwing good money after bad has ended,” Kevin Bishop, a spokesman for senator Lindsey Graham (R-SC) told CNBC. “We're talking about certain banks … temporary surgical stabilization.”

Banks, perhaps that are large enough to be critical to the nation's financial system. Banks like Bank of America and Citigroup, if investors voting with sell orders on Friday have any prescient insight to impart.

Write to Paul Jackson at paul.jackson@housingwire.com.

Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.

In the last few days, I’ve read a chunk of the faith-based commentary on the Administration’s new Homeowner Affordability and Stability Plan. The media, whether they pretend it’s news (in which case their coverage is “infotainment,” or blogging from an assigned workplace during defined working hours) or call it commentary or opinion (in which case, it’s proto-blogging), do not make extensive use of facts about any of the mortgage businesses or markets implicated in the current economic disaster. Or, worse yet, facts are invented or misappropriated to seemingly suit a writer’s deadline or agenda. (Or both.)

This coverage doesn't provide much of the real-world context in which all of these bailout and rescue plans must actually function — or against which their likelihood of success or failure actually needs be assessed. This is not just an ivory tower complaint. Many of the last Administration’s interventions unleashed serious “unintended consequences,” because they did not consider the context in which they were acting broadly enough. And the press has not been any better able to anticipate the garbled results.

My first example of dithering without digging into the real market issues comes from an recent editorial in the Wall Street Journal (Dukes of Moral Hazard, Feb. 18). They focus on the first big element of the Plan, expanding refinancing for responsible homeowners:

The Administration is not really covering new ground here — they are addressing a problem embedded in the GSE charters that has prevented borrowers in good standing from refinancing existing GSE loans because falling home prices have reduced their equity below 20 percent of the property value.

The GSE charters, created by Congress, prohibit the GSEs from financing (through a purchase or guarantee) more than 80 percent of the property value. If the LTV is higher, the loan must have third-party credit support.

Historically, this credit support has been in the form of PMI, but in the bubble-building years, borrowers found piggy-back second mortgages less costly (because they were securitized and off-loaded into CDOs and yield-hungry funds). As much as the GSEs have tightened their credit standards, PMI underwriting is even tougher, and their insurance premiums have gone up to reflect the realities of mortgage risk.

The really “sweet deal” out there is available to FHA borrowers (and this is why FHA lending and Ginnie Mae issuance is booming). In return for upfront and monthly insurance premiums, a home buyer or owner looking to refinance a private or GSE loan can borrow roughly 97 percent of the appraised value. For the time being, given the housing crisis, the FHA has been barred from risk-pricing those premiums.

Even sweeter is the refi deal for existing FHA borrowers. If they are current, they can do a so-called streamlined refinancing, which eliminates most of the documentation and hassle — including the requirement for a new appraisal. The rationale is — I think — a sound one: the borrower is current and even if the loan is “underwater,” the homeowner has clearly signaled that the house is a home and not a used up ATM.

The FHA has the legal authority to operate this way and has used it since they introduced streamlined refinancing in the late 1980s. The GSEs followed suit — sort of — by reducing documentation and processing time. And they would waive the appraisal if the lender would provide “reps and warranties” that the original appraisal was still valid (an acceptable form of third party credit support, as it gives the GSEs recourse to the lender).

Reps and warrants worked when home prices were going up, but they stopped working when home prices started down. The mortgage market has been well aware of this problem. The disparity between loan application activity reported by for government and “conventional” loan programs is clearly evident in the weekly MBA application surveys, and Mortgage Maxx AFS (another loan activity monitoring service aimed at estimating prepayments over short-term horizons) has been commenting for many months on the low completion rate of mortgage applications, largely owing to insufficient equity.

For mortgage investors, this problem translates into an impediment to prepayments that, for example, extends the duration of a GSE MBS investment compared to a Ginnie Mae. Mortgage investors — and the research analysts on the Street who track prepayments and other drivers of relative value — have paid considerable attention to this issue over the last year or so. A lot of weekly research has been published addressing the topic, with many solid analysts suggesting that Congress would have to revisit this problem soon in order to provide this OBVIOUS relief to borrowers.

It's hard to believe that the WSJ has missed this discussion, but can still quote from Credit Suisse-led research into redefault rates.

Maybe they thought prepayment commentary was too technical. But it's hard to believe that the long-time GSE critics at WSJ missed Fannie Mae’s attempt earlier this month to streamline refinancings. The program change allows certain borrowers underwritten in its automated loan processing system to forgo a formal re-appraisal if they were applying for rate refis (called limited cash outs, because the loan amount could be raised slightly to cover fees and closing costs). The automated system uses current home price data and other information to perform a check on property value. Given other credit criteria are met, Fannie Mae was willing to accept this measure of value.

To go farther would require either action by the Congress (oh no! not a lot of hearings and partisan debate and maneuverings, too!) or some form of credit support from the lenders, possibly backed by the kind of guarantees or credit enhancements authorized under EESA. I think it’s safe to say that the Administration is still working through the strategy it thinks will be easiest to institute and implement.

OK — so maybe that wasn’t fair to take an outright editorial to task for massaging the facts. Let’s take “news” coverage of the Plan instead. Both the Washington Post and the Financial Times make similar mistakes about fully streamlining GSE rate refis.

Let’s move on to the next major component, the modification plan. The press seems to doubt it can work because it’s voluntary. A little fact checking will discourage that point of view. The Washington Post’s “Obama Proposes Package to Stave Off Foreclosures” (read it here) is a litany of shortcomings, including the assertion that the program would be voluntary.

First of all, it will be required for recipients of FSP (the new name for TARP Capital Purchase Program). Those recipients include the largest U.S. and regional banks, who control at least 60 percent and more of outstanding mortgage servicing in the U.S. Secondly, the Administration intends federal financial services regulators to implement these guidelines among the institutions they regulate. There might be a delay drafting regulations and taking comments and all that, but it does not sound like it will be voluntary by any stretch of the imagination.

The universal application of standardized modification procedures may also resolve a couple of the real-life obstacles to modifying loans in securities. Here’s the Financial Times, with “Housing Plan Aims to Reduce Monthly Bills”:

First of all, previous standardized loan modification programs have been voluntary, and they have maximized the moral hazard in modification by requiring the borrower be delinquent. I know how I’d feel if I started missing payments — I’d be paranoid and defensive. I’d either be in full blame-others mode, or locked into denial. This program sets a debt-to-income trigger for eligibility — also clean, but borrowers who want help won’t be told to call back when they are delinquent.

Standardization speaks directly to the leading obstacle to modifying loans that have been securitized — fear of investor lawsuit. There is variation across documents, but in general the governing documents employ a general servicing standard (I’m relying here not on recollection, but on testimony of Stephen Kudenholdt, head of the structured finance practice at Thacher, Proffitt & Wood LLP delivered November 14, 2008 in a hearing held by the House Oversight and Government Reform Committee). Typically the servicer is required to follow the accepted servicing practices it would employ “in its good faith business judgment” and which are “normal and usual in its general mortgage servicing activities” or in servicing loans for its own account. These include loss mitigation activities.

The Administration guidelines in effect become the normal and usual practice. Not a bulletproof defense against lawsuit, of course, but it should give comfort to servicers (they still can only modify when the NPV of the modification is greater than the NPV of a foreclosure). I could be wrong, but I think this is primarily why JPMorgan Chase (JPM: 37.21 -0.75%) CEO Jamie Dimon repeatedly asked for standardized modification practices during the House Financial Services Committee hearing last week on Tarp Accountability. (And, in fact, Mr. Dimon applauded this feature of the Plan to the Washington Post.)

Another real-world feature of the Plan misunderstood in the press expands the Treasury’s funding commitment to Fannie and Freddie and increases their ability to buy loans and MBS by lifting their portfolio and debt ceilings.

Here’s the NY Times, “Obama Housing Plan Tries to Slow Downward Spiral”:

Please. This misunderstanding could be cleared up with a single phone call to one of dozens of professional MBS traders, analysts and investors working in the Mid-Town area alone (just blocks from the Times Building, it should be noted).

This provision of the Plan reflects an understanding of the real world dynamics of the MBS markets. The GSE’s portfolio purchases effectively established a floor on MBS prices when interest rate volatility or supply put them under pressure. In effect, the GSE’s purchases protected all the other investors, including the foreign central banks, pension funds, mutual funds, banks and insurance companies who have important stakes in the market. Capping those purchases may have pleased the critics of GSE systemic risk, but it pulled the rug out from under those investors.

Simply put, soft demand for MBS means lenders have to raise the rate on loans packaged as MBS. The Federal Reserve has been buying MBS to supplement that demand, but it has been swimming upstream. These moves reassure foreign and other investors that the government is supporting the GSEs and that the GSEs will be allowed to support the MBS market. Frankly, I think this is key — the Treasury is going to be issuing a lot of bonds in coming months and years, and the Federal Reserve needs dry powder to buy a few of those as well.

The Plan isn’t perfect, and it’s clearly not finished, but in my humble opinion it reflects this Administration’s effort to get on the ground and figure out what works and doesn’t work in the actual mortgage businesses and markets that still exist.

Editor’s note: Linda Lowell is a 20-year-plus veteran of MBS and ABS research at a handful of Wall Street firms. She is currently principal of OffStreet Research LLC.

Seasonally-adjusted initial unemployment claims came in at 627,000 for the week ending Feb. 14, unchanged from the week before, according to weekly data released Thursday by the U.S. Department of Labor. The four-week moving average, a steady indicator of seasonal trends, showed a 10,500-claim increase to 619,000, suggested an increased state of joblessness overall. The seasonally-adjusted insured unemployment rate rose slightly to 3.7 for the week ending Feb. 7.

The largest increases in unadjusted initial claims for the week ending Feb. 7 occurred in Kentucky  (with an additional 8,419), Arkansas (with an additional 4,142), Illinois (with an additional 3,630), Texas (with a 3,392-claim rise) and Missouri (with 3,217 more claims). The largest decreases in unadjusted initial claims occurred in California (which was down 5,249), Tennessee (with 1,718 fewer claims), Iowa (with 1,413 claims less), Connecticut (with 1,267 fewer) and South Carolina (with 1,059 less claims), according to the data.

The highest insured unemployment rates in the week ending Jan. 31 occurred in Michigan with 8.1 percent, Idaho and Oregon with 7 percent each, Pennsylvania with 6.4 percent, Wisconsin with 6.3 percent, Nevada with 5.9 percent, Alaska with 5.8 percent, Montana with 5.6 percent and Indiana with 5.5 percent.

The historic unemployment claims highs have sparked a number of relief efforts. On Feb. 5, the Department of Labor announced a $22 million grant to assist rank-and-file workers affected by financial industry layoffs in the New York, Connecticut and New Jersey area. "Due to the crisis in the financial system, thousands of people lost their jobs through no fault of their own," said acting secretary of Labor Edward Hugler. "The services provided through this grant will assist front line and back office workers in getting back to work as soon as possible."

Layoffs, in combination with falling home prices, have often been linked to the sweeping rate of foreclosures. Advocates of a housing stimulus have long argued the merit of relief for laid off workers finding themselves unable to make mortgage payments. Such borrowers represent a portion of the intended recipients of the $75 billion Homeowner Affordability and Stability Plan announced Wednesday by President Barack Obama. The plan aims servicer-implemented loan modifications and government-subsidized rate cuts to increase payment affordability for homeowners at risk of falling behind on their mortgages.

Write to Diana Golobay at diana.golobay@housingwire.com.