Let’s Continue To Protect FHA For The Long Term

Each November HUD releases it’s FHA Actuarial Report to Congress. This is a congressional mandate based on a history of FHA finding itself under capitalized risking draws from its “permanent and indefinite” authority as provided to draw funds from the Treasury should it have insufficient reserves in place to cover forecasted losses on it’s book of business. This years 2018 independent Actuarial Report on the health of the MMI fund continues to affirm my concern that we stay committed to not weaken the fund despite calls from some to reduce premiums or modify the premium structure.

As a former FHA Commissioner, I excitedly await these releases each year having walked into that role in 2009 when the fund was already destined for trouble. As a matter of fact, and to remember this history, I testified to to this concern in my confirmation hearing in front of the Senate Banking Committee in April of 2009 and asserted what we all knew – that the MMI fund was in trouble, “FHA has not been immune to the adverse conditions of this market. Default rates and foreclosures exceed prior estimates.“, was one of my statements to this point.

To be clear, the FHA is unlike any private or other government sponsored provider of credit. It is a massive insurance company that guarantees reimbursement to GNMA MBS investors for the full value of loss associated with an FHA default. This guaranty is backed behind loans that have higher risk characteristics than loans backed by the GSE’s. FHA loans combine higher debt to income ratios, lower credit scores, and higher loan to values than their other government sponsored counterparts. And as you can see by the report issued by Isaac Boltansky of Compass Analytics it is trending worse. As shown below, the trend in both credit score and DTI in the FHA portfolio is weakening:

FHA is unique and important in the single family housing market in other aspects. It serves minorities and first time homebuyers in manner unmatched by any other credit provided in the US. It is the largest provider of reverse mortgages for seniors in the nation. And lenders that help distribute FHA loans across the nation are dominated by non-bank, independent mortgage bankers, primarily because the major bank lenders have backed away from the program due to concerns related to indemnification risk that may obligate them to severe financial penalties in the event of default, a subject that I have been vocal about for years.

The MMI fund also backs the far riskier reverse mortgage program (HECM), a product that has whip-sawed the reserves significantly over the years and in this years report reflects its ongoing concern to taxpayers as shown in Isaac’s analysis comparing the forward and reverse books.

In short, the concentration of credit attributes in the FHA portfolio contain more risk factors across the spectrum than loans created by Fannie Mae or Freddie Mac or most other private lenders. The good news is that this year the actuarial shows that the capital reserves continue to grow above the base minimum of the 2% legislated floor, standing at 2.76%. But risk remains and we have learned through history that the reserves held today still may underestimate the true loss exposure in a nationwide recession. In an economy with virtually full employment, low interest rates, and stable house prices, it would be ludicrous to forget the realities of economic cycles as we have seen in the past. Yes, FHA has rebuilt its financial resources. But holding 3.89% in capital resources on it’s massive $1.26 trillion portfolio is minimal on a risk adjusted basis.

Recently some of my industry colleagues have called for either an outright reduction in premium or an elimination of the lifetime premium. I oppose either move at this juncture. In fact, as commissioner I made several moves to protect the fund including raising premiums with congressional support, establishing a credit score minimum, and installing life of loan MIP, and would argue against moves to the alternative until we see more improvements in the HECM program and understand the economic cycle we may be facing in the years forward.

I installed the life of loan MIP for one key reason. FHA, unlike the MI elimination policy in the GSE program, still remains on the hook for losses even if the premium is cancelled. Just as you pay for auto, health, or other insurance as long as you are under its protection, FHA needs to do the same. In 2009 after home prices dropped nationally over 20% and in some regions between 30%-40%, we found that we were obligated to pay for losses on homes where the MIP was not being collected due to previous elimination based on equity, and yet many of these homes were not underwater due to the price corrections in the recession. Because there is always risk in HPI forecasting it was our view that a premium must be paid as long as the insurance is in place. Not only does this add significant economic value to the fund, it protects the integrity of its administrators to make certain that appropriate premiums are applied to all insured borrowers. While some might argue adverse selection in interest rate rallies or periods of property value appreciation for better qualified borrowers who refinance out of the program, I would argue that the math does not offset the down side forecast risk to home prices as projected in any actuarial.

Look, I am not saying that FHA should never consider reducing premiums. But keep in mind that all net earnings are booked as reserves for future losses and without getting into the confusing explanations of federal budgeting and spending, these reserves are critical to keep FHA well supported during down markets. We are in the best credit cycle seen in decades. We have had low interest rates, record low unemployment, and nearing a decade of home price gains. FHA has insured the best credit books perhaps ever seen its history. But the HECM program remains a huge problem and we have not tested mortgage performance in a down cycle yet. With both credit and LTV drift, some counter parties facing potential capital and liquidity concerns, and many forecasting a weakening economy in the next couple of years, this is the time to remain vigilant and continue to build the reserves until there us unanimous confidence in this ability to withstand a negative cycle.

I applaud the fortitude of my friend FHA Commissioner Brian Montgomery in holding back on any MIP changes and I would suggest that most former commissioners would have a similar view. All stakeholders in housing and mortgage finance need to protect FHA from future scrutiny due to short sighted acts that could jeopardize its long term role in serving homeownership. Let’s protect the FHA.

Let’s Continue To Protect FHA For The Long Term

Capital View

Each November HUD releases it’s FHA Actuarial Report to Congress. This is a congressional mandate based on a history of FHA finding itself under capitalized risking draws from its “permanent and indefinite” authority as provided to draw funds from the Treasury should it have insufficient reserves in place to cover forecasted losses on it’s book of business. This years 2018 independent Actuarial Report on the health of the MMI fund continues to affirm my concern that we stay committed to not weaken the fund despite calls from some to reduce premiums or modify the premium structure.

As a former FHA Commissioner, I excitedly await these releases each year having walked into that role in 2009 when the fund was already destined for trouble. As a matter of fact, and to remember this history, I testified to to this concern in my confirmation hearing in front of the Senate Banking Committee…

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The Moelis Plan – Putting The Cart Before The Horse

The team from Moelis has unveiled a new and somewhat improved version of their plan to return the Government Sponsored Enterprises to the shareholders. Before turning to the substance, much of which is quite good, it’s important to note up front that they have the interests of their clients, who are major shareholders in the GSEs, foremost in mind here. This is not a criticism of Moelis, which is doing what it is being paid to do, and admirably I must say, but something to keep in mind in understanding the effort, as some key features only make sense in that light.
What Moelis gets right:
1. It is important to appreciate what pushed the GSE’s into conservatorship in the first place. Moelis makes the point that it was not the core TBA guaranty book but rather the actions taken with the portfolios of both firms in purchasing lower quality and riskier PLS, subprime, and alt-a mortgage product. In leveraging their implicit federal backstop, they had an almost unlimited execution advantage in disrupting the non agency markets.
2. The principles set forth by Moelis appeal to most stakeholders. This includes a list of items including protecting the taxpayer, leveling the playing field permanently for all lenders regardless of size, and affirming the affordable lending regime that currently exists today. It references the joint trade association letter and endorses the calls made in that document to lock in many of the reforms that were made by policy under Director Watt and his team. Frankly much of that was initiated under then Acting Director DeMarco.
3. Moelis lays out a pro-forma outlook at the future financials and how the taxpayer might profit from their proposal. While I will leave the details of this to others with more expertise to debate, I will note that it is at the very least counterintuitive. Today all profits from both institutions go to the taxpayer, so it is difficult to imagine how the taxpayer would manage to reap greater returns by selling its position. I’m not saying it’s fair or good policy, but as a matter of taxpayer math, it’s hard to see why this is a positive.
 4. Moelis goes to great lengths to diminish the GNMA operational model proposed by the recent discussion draft released from Congressman Hensarlings’ office. To this point I am in complete agreement about the understaffed, overwhelmed, undercapitalized aspects of GNMA today and the stark comparison to the capabilities of the GSE’s in their current form. There is simply no comparison and the false belief that GNMA can serve this role is far fetched at best. Moelis adds some key points that others have made in the past especially the value to small lenders that would be likely lost including access to a cash window and the ability to buy defaults out of pools. The GNMA model likely increases concentration risk on large banks, not the opposite.
What Moelis Gets Wrong:
1. The plan starts with recapitalization. In essence, they are putting fuel back into the tank of the car before it is fixed. This poses the very real risk that we never fix the car adequately before it’s entirely refueled and ready to drive off. This makes no sense at all as a matter of public policy, as it increases the odds that we skip reform altogether. But it makes a great deal of sense for shareholders, as it increases the odds that they recoup dramatically with or without reform. Assuming we should think of this from the perspective of the nation and not the shareholders, the focus here must be reform first. If we cannot get the structure and framework right, we sure as heck better not have them on the edge of release. Frankly, the housing system might be better off retaining the current structure than letting free market capitalism with a government backstop back out in the open before insuring that they are framed in with the appropriate policies and a commitment behind them and to the markets for safety and sustainability first.
2. While agreeing that an explicit federal backstop is needed, Moelis explains that this requires legislation. And, while recognizing that this would help MBS pricing and likewise lower interest rates for borrowers, it does not seem to make this a cornerstone event. In the absence of a congressionally authorized explicitly guaranty behind the MBS, investors in a forward looking global market will ultimately have to believe that the US Government will bail these entities out in the future just as they did a decade ago. Sovereigns would have to determine whether their institutions could trust this model and consider its risk weighting in the same manner as they do today. This could have meaningful impact to interest rates and consumer access to credit.
3. This leads to the next critical point. The plan leaves in place the duopoly model. Unless we end the system’s reliance on a TBTF duopoly we are simply not addressing the fundamental flaw in incentives that got us into so much trouble. You can do that by increasing the number of guarantors so that any one can fail, or collapsing them into one that is treated like a market utility. But you’ve got to do one or the other to have any real reform.  The duopoly model would be the worst of all outcomes, resulting in too much risk and too little competition.
4. Moelis argues that the regulator can protect the level playing field, continue the affordable housing goals, and frame in the charter creep concerns. The reality is that the effectiveness of any regulator varies by regime and leadership. We have seen that stark contrast in other regulators just in the past two years. The confidence in relying on regulatory infrastructure that is subject to change versus the more concrete and permanent changes established by legislation are important decision points. With the view about getting this right before we march to recapitalize and monetize speculative shareholders, I continue to advocate that reform before recapitalization must be protected in this debate.
Conclusion: The conservatorship has lasted too long and ending it will take political will that thus far we just haven’t had. The alternative presented by Moelis is tantamount to giving up, putting Fannie and Freddie on a path to re-privatization. But it makes no sense from a matter of public policy, as even conservatorship is better than a return the system that has failed us already. Indeed, it only makes sense from the perspective of the shareholder. But surely the needs of the housing finance system must come first.
Let’s avoid putting the cart before the horse. Let’s continue to pursue legislation and unite around the need to establish an explicit guaranty, prohibit pricing for market share, establish more rational and effective affordable housing measures, frame in the permissible activities of the future entities, and implement a capital regime that will stand the test if time. Any other action at this point leave open the slippery slope back into the abyss that resulted in the bailout to begin with.