Two days after he was sworn in as the new head of the Federal Housing Finance Agency, Mel Watt effectively fired a salvo across the bow of private capital when he announced that he is delaying plans for a 10-bps hike in guarantee fees for all mortgages securitized by Fannie Mae and Freddie Mac.
Watt also put a hold on a planned update to the g-fee grid and the elimination of the upfront 25 basis point adverse market fee this year.
The hikes, which were part of the ongoing series of steps by outgoing FHFA head Ed DeMarco to attract private capital back into market, could still be implemented but Watt has already signaled he plans a more activist agenda.
That could lead the mortgage market back down the road to conditions seen in 2006, says Ed Pinto, resident fellow and co-director of the American Enterprise Institute’s International Center on Housing Risk.
"(Watt) is obviously going to be an activist director which means he’s going to use the full extent of his congressionally delegated authority to implement things like the Housing Trust Fund," Pinto said. "My expectation will be that he will strengthen the affordable housing mandates, which he has unfettered authority to do. Those are the same mandates that got us into trouble when they were exercised (at the U.S. Department of Housing and Urban Development.)"
"I believe his policies will slow down the flow of private capital in the $10 trillion mortgage market," Pinto added.
Jim Bruce, a contrarian investor and the filmmaker behind the new documentary “Money for Nothing: Inside the Federal Reserve,” says he is likewise worried that he sees a lot of the same factors in play now that were first experienced back in 2007, and Watt’s policies could exasperate the situation.
"My big concern is that in some ways, but not all, the Fed has returned us to 2007 – assets of all kinds including home prices are rising rapidly – but what made the housing bubble so unique is it was built on such shaky foundations," Bruce said. "It’s hard to gauge where we’re at right now – but the feedback loop is in place. In general real estate seems to be moving where we were before crash."
Like Pinto, he worries that Watt will drive for more policies – well-intended to help lower income buyers get into homes – and will ironically drive up home prices and make mortgage-backed securities more risky.
"Housing prices are rising far greater than income or inflation," Bruce said. "That’s not a good position."
DeMarco’s steps at FHFA toward normalization were prudent but deliberate. He announced his plans a year in advance and those steps were designed to reduce the size of Fannie Mae’s and Freddie Mac’s market share. In 2011, Congress passed statutory mandates that required Fannie and Freddie g-fees to meet certain standards sufficient to meet requirements for private investors. It is generally recognized that g-fees are well below that standard.
Another statutory mandate was that g-fees be priced on a risked-based basis meaning lower down payment loans had to carry their weight. The third statutory mandate was to eliminate the discrimination between small and large lenders that had nothing to do with anything but volume.
DeMarco was trying to get Fannie and Freddie to meet those mandates, Pinto said, but he sees that effort being abandoned.
"The tilt will be much more toward the affordable housing mandate portion so that there’s cross subsidies creeping back in, lower lending standards, and so on," Pinto said. "The effects are going to be tremendous. His leadership will bring a substantial change in direction that will return them back to same risk levels we saw before the crash. Already underwriting standards are much looser than they were in 1991-92."
The bottom line, according to Pinto?
"The two changes Watt will bring will destabilize the market – he will back Fannie and Freddie away from steps to bring in private capital and he’s going to expand the underwriting box to meet affordable housing goals," Pinto explained. "Stable housing markets depend on at least half of loans being low risk and we’re already slipping below that."
Ironically, keeping out private capital and pursuing “affordable housing” goals actually hurts homebuyers, especially those on the lower income scale.
"These policies put people in houses they can’t afford and jack up home prices," Pinto said. "The Federal Housing Administration showed that sound underwriting puts people in homes they can afford. All the efforts to expand underwriting hasn’t helped homeownership since the 1960s.
"Instead what we will see is Freddie and Fannie maintaining 70-80% market share, and they could stay in conservatorship for another five years. They’re already coming up on their sixth year already, and the exemption they have under the Consumer Finance Protection Board’s (CFPB) Qualified Mortgage (QM) rule increases that likelihood."