The spread on mortgage-backed securities (MBS) trouble many industry professionals, and at a recent roundtable discussion, it spurred an interesting discussion on the degree of risk being absorbed by Fannie Mae and Freddie Mac.
At policy panels held by the Community Home Lenders of America (CHLA) on Monday in Washington, D.C., former Federal Housing Financing Agency (FHFA) director Mark Calabria made the argument that a larger credit box has caused the government-sponsored enterprises (GSEs) to take on far more risk than they should be.
Taylor Stork, the president of CHLA and the chief operating officer of Developer’s Mortgage Co., asked Calabria about a previous comment that 10% of the high MBS spreads could be attributed to credit risk — even though, according to Stork, the credit box is largely the same today as it was five years ago. Calabria disagreed.
“There’s been an explosion in high-DTI lending since I left FHFA,” he said, pointing to the fact that some Federal Housing Administration (FHA) borrowers have a 57% debt-to-income ratio. DTIs on Fannie- and Freddie-backed loans have also risen, he said.
“What we saw during COVID was the No. 1 predictor of who took forbearance was DTI,” Calabria told the crowd. “I know there are a number of people in Washington who say DTI doesn’t matter. It sure as hell does. When you start to see a world where homeowners insurance and property taxes all go up, we’ve got borrowers hovering around a 50% DTI. That’s not a healthy situation.”
Jim Parrott, a former White House housing official under the Obama administration, who is currently a nonresident fellow at the Urban Institute, said the GSEs would disagree with Calabria’s characterization that they’re chock-full of unacknowledged risk.
“They would say their credit on an annual basis is the lowest it’s been in a long time,” Parrott said, noting that Fannie and Freddie recently released a substantial amount of cash through credit risk transfers.
Calabria also argued that the GSEs have taken on risk they didn’t want.
“I was surprised when one of the GSEs, in explaining some of the credit choices, directly told me, ‘We would have never done that. We were ordered to get that additional risk,'” Calabria said.
“And I think one of the things that’s underappreciated is the conservatorship does not reduce the risk of GSEs. Companies are far more fiscally conservative than the conservatorship has been.”
Calabria also disagreed with an audience member’s claim that roughly 100 basis points (bps) could be found if the government became a large MBS purchaser again. He argued that there are maybe 40 to 50 bps between prepayment and credit risk that could be worked with.
Calabria added that Fannie and Freddie are still massively leveraged, and there’s a regulatory regime that is supposed to remove them from conservatorship rather than creating a dumping ground for risk.
“If you don’t fix them, the ability legally to take additional risk is constrained,” he said. “Even if you start to soon see a 25-, even 50-basis-point change for the Fed, the environment we’d have to get into before I see the Fed be a large-scale buyer of agency MBS again, you don’t want to be in that environment.
“I think we do need to have a broader conversation. It’s a Dodd-Frank conversation as well,” Calabria added. “One of the things we ran into in March 2020 was all the MBS dealers were up against the wall because of capital standards. So, I guess, I put it this way: Yes, we completely screwed off the MBS market. We should fix it, but I’m not sure that simply having it dumped directly on the Fed or the GSEs is the appropriate long-term fix. But it’s a problem.”
