The loan repurchase policies of Fannie Mae and Freddie Mac are one of the factors that have exacerbated the U.S. housing crisis and impeded economic recovery, according to two recent releases by notable federal government actors. These reports call into question whether the aggressive repurchase stance of the Federal Housing Finance Agency, as conservator of the GSEs, to reduce short-term losses to U.S. taxpayers instead might work to the long-term detriment of such taxpayers. Lenders reportedly responded by saying: “like, duh!”
The Board of Governors of the Federal Reserve System (the “Board”) issued its White Paper, entitled “The U.S. Housing Market: Current Conditions and Policy Considerations” on January 4, 2012. Noting that the prolonged problems in the U.S. housing market continue to impede the economic recovery, the White Paper identifies among other causes “a marked and potentially long-term downshift in the supply of mortgage credit” which contributes to weakness in housing demand. Some tightening of mortgage lending standards was necessary to overcome the prior lax standards, but the extraordinarily tight standards that now prevail, according to the White Paper, “reflect, in part, obstacles that limit or prevent lending to creditworthy borrowers.” The White Paper cites data indicating that less than half of lenders are currently offering mortgages to borrowers with FICO scores of 620 and a down payment of 10% notwithstanding the eligibility of such loans for purchase by the GSEs. It attributes this hesitancy of lenders in part “to concerns about the high cost of servicing in the event of loan delinquency and fear that the GSEs could force the lender to repurchase the loan if the borrower defaults in the future” based on alleged breaches of loan level representations and warranties.
Confirming what the lending industry has been saying for some time, the White Paper highlights the conundrum of federal housing policy: “Aggressively putting back delinquent loans to lenders helps the GSEs maximize their profits on old business and thus limits their draws on the U.S. Treasury, but at the same time, it discourages lenders from originating new mortgages.” The Board suggests that short-term losses by the GSEs actually might be in the interest of taxpayers “if those actions result in a quicker and more vigorous economic recovery.”
William C. Dudley, the President and Chief Executive Officer of the Federal Reserve Bank of New York, drilled down further to explain what is wrong with the GSE repurchase policies in a speech to the New Jersey Bankers Association Economic Forum on January 6, 2012, entitled “Housing and Economic Recovery.” Like the White Paper, the speech focuses on the extent to which the problems in the U.S. housing market impact economic recovery. He also notes that the restoration of housing demand requires reasonable access to mortgage credit for eligible borrowers and that steps should be taken to improve such access. He validates the oft-stated position of lenders that they are discouraged from making new prime conforming loans “due to excessively stringent put-back rules on these mortgages.”
Mr. Dudley explains that the cause of the lenders’ concerns revolves around the lack of a link between the alleged breach of a representation and warranty and the cause of a borrower’s delinquency, saying that GSE rules afford them a “broad scope to force the originator to repurchase at par loans that go delinquent if there are any errors in the mortgage loan paperwork—even if the error has no direct link to the delinquency.” He basically argues that lenders should not bear the economic risk of a borrower’s job loss. While making it clear that lenders should be held accountable for their representations and warranties, he is looking for penalties that are more appropriate. By exposing lenders to significant credit risk through the current repurchase regime, argues Dudley, lenders are encouraged to focus only on the lowest risk customers and apply tougher restrictions than required by the GSEs “in order to limit the risk that they will have to take back such loans when they become delinquent.” He suggests that the insertion of a materiality test would foster a better balance between incentives for sound underwriting and credit availability. He also suggests that in the future representations and warranties should have a finite duration but be supplemented by a rigorous, real-time quality control check of the underwriting based on a random sample of the loans.
Read together, the White Paper and the Dudley speech give voice to the profound consternation of the lending industry that the GSEs unfairly are seeking to reallocate the credit risk of loss for delinquent loans on sellers and servicers when such losses are the result of post-sale changes in the circumstances of the borrower. The fact that one branch of the federal government is criticizing another branch of the federal government should not be that surprising, given the lack of a comprehensive, holistic approach to federal housing policy. What really is going on, I suspect, is that the Board is providing an intellectually honest foundation to the FHFA, as conservator for the GSEs, to conclude that the continued aggressive pursuit of loan repurchase claims without regard to the materiality of the breach or the cause of the loss is contrary to the FHFA’s statutory mandate to protect the interests of the taxpayers. Hard to argue with that one.