FHFA’s Watt May Rescue Housing With Lower Risk to LendersKathleen M. Howley
Melvin Watt, the overseer of Fannie Mae and Freddie Mac, broke five months of silence to help boost lending as slowing sales threatens the housing recovery.
Watt, 68, in his first speech as director of the Federal Housing Finance Agency, announced new rules to reduce the risk that lenders will have to repurchase bad mortgages. The changes, designed to allow banks to relax credit standards, probably will increase housing sales by 5 percent this year, said Stephanie Karol, an economist at Englewood, Colorado-based research firm IHS Inc.
“It means a restart for the real estate recovery,” said Mark Zandi, chief economist of Moody’s Analytics Inc. “We’re not going to get back on track until we start making credit more available to potential buyers.” He said he expects Watt’s moves to spur “meaningful” sales growth.
A combination of tight credit, rising home prices and a retreat by investors has dragged down the market. Sales of existing homes fell to a 20-month low in March, according to the National Association of Realtors.
Lenders use “overlays” -- restrictions tougher than those required by Fannie Mae and Freddie Mac -- to reduce the chance of default on loans sold to the government-run companies. They force lenders to repurchase these soured loans when they contain underwriting errors. Lenders had to absorb buy backs with a balance of $81.2 billion between 2011 and 2013 alone.
Banks such as Wells Fargo & Co. and Bank of America Corp. typically cap a borrower’s total debt-to-income at 36 percent to quality for a mortgage, according to Keith Gumbinger, vice president of research firm HSH Inc. In some cases, Fannie Mae and Freddie Mac will back mortgages with DTIs above 43 percent, Watt said.
“I know that repurchase risk remains a top concern for the mortgage industry,” Watt said in his May 13 speech at the Brookings Institution, a nonpartisan think tank in Washington. “Lenders believe that too much uncertainty still exists in this area for them to ease their credit overlays. Ultimately, this undermines the goal of improving access to mortgage credit for creditworthy borrowers.”
Watt said discussions with Fannie Mae, Freddie Mac and lenders led him to make a number of refinements to the buyback process. Bankers will be freed of liability for bad mortgages after three years of monthly payments even if borrowers are late twice during that time. Lenders also will be off the hook if loans pass new underwriting spot-checks. And, when mortgage insurance companies refuse to pay a claim on a bad loan, lenders won’t automatically be expected to cover the loss.
Karol, the IHS economist, said the changes will probably lift sales enough to turn around the market. Prior to Watt’s speech, she had forecast 4.96 million home sales for 2014, down from 5.07 million last year. Now, she puts 2014 sales at 5.21 million.
“The message to bankers was, it’s OK to stop white-knuckling the credit process,” said Karol. “It’s going to make lenders more willing to give people a chance.”
While Watt can’t force banks to lower credit standards, he can spur originations by reducing buyback demands, according to a report by Jay McCanless, a senior analyst with Sterne Agee & Leach Inc. in Nashville, Tennessee. With the new FHFA guidelines taking effect on July 1, they will likely boost home sales by a small amount starting in September, McCanless wrote.
Watt also conveyed in his speech that the FHFA was taking a more productive approach to working with lenders, McCanless said in an interview. Watt, an appointee of President Obama, took over in January from Edward Demarco, who became acting director in 2009 after serving as No. 2 at the agency under President Bush.
“The FHFA under Demarco was very contentious, with Fannie and Freddie demanding banks repurchase a large volume of loans and pay fines,” McCanless said. “Watt was signaling the companies are going back to a more constructive relationship with banks.”
Some analysts are less bullish about the impact of the lending rules. Anish Lohokare, an analyst with BNP Paribas SA in New York, said Watt’s moves won’t be enough to turn around a plunge in mortgage originations. Lending dropped to $226 billion in the first quarter, compared with $524 billion a year earlier, according to the Mortgage Bankers Association in Washington.
“Against the backdrop of low origination profitability, higher mortgage rates relative to last year and lower housing affordability, the changes announced are not likely to be a game changer,” Lohokare said in an email.
Overlays likely will continue because banks want mortgages that earn revenue and seek to avoid the costs of delinquencies, Bank of America Chief Financial Officer Bruce Thompson said when asked about Watt’s remarks a day later at a banking conference in London.
“While from a policy perspective, we’re optimistic some of those changes will help the overall environment, as a company what we’re focused on is structuring mortgages” so they are unlikely to go sour, Thompson said. “As we move forward, we’re just not interested in putting on loans that are going to have heavier-than-average delinquent content.”
Spokespeople for Bank of America, Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo declined to comment for this story.
When Obama nominated Watt to head the FHFA last year, the president described the difficult childhood living conditions that first gave Watt an interest in housing policy.
Watt “grew up in a house where you could see the stars through the roof and the ground through the floor,” the president said. His childhood home lack electricity and indoor plumbing, according to HistoryMakers, a nonprofit in Chicago that documents the lives of prominent African Americans.
A graduate of Yale Law School, Watt worked as a civil rights attorney before entering politics. He was elected as a Democratic congressman from North Carolina in 1992.
In Congress, Watt worked to stiffen oversight of lenders and introduced a bill in 2005, during the height of the mortgage boom, to regulate subprime lending long before other politicians saw it as an issue.
Until last week, Watt had made no public statements since taking over as regulator of the companies that back about two-thirds of mortgages in the U.S. Fannie Mae and Freddie Mac, which buy loans and package them into securities, were seized by regulators in 2008 and received a $187.5 billion bailout. They now earn record profits.
The FHFA head announced he was overturning a goal set by former director Demarco to shrink the number of loans securitized by the companies to encourage private investors to enter the market. He also said he would not reduce the cap on the size of individual mortgages eligible for purchase, known as the conforming loan limit, reversing a plan announced by Demarco last year.
A reform bill, passed by the Senate Banking Committee last week, would go further by replacing the two companies with a reinsurer of mortgage bonds.
“FHFA is focused on how we manage the present conservatorships of the Enterprises and the present housing finance market under the present statutory mandates,” Watt said. He paused and repeated the line a second time, raising his finger for emphasis, before continuing.
“One topic that is not on FHFA’s agenda, because it’s not part of our statutory mandate, is housing finance reform legislation,” said Watt. It’s the job of Congress to make those decisions, he said.
Watt is now considering another set of changes to further improve the flow of credit. He may create an independent dispute resolution program for lenders to challenge buybacks and provide ways for lenders to fix faulty loans without repurchasing them.
“Since any stumbles along the way could have ripple effects in the $10 trillion housing finance market, there’s a lot at stake in getting this right,” Watt said in his speech.