Editor Jacob Gaffney and reporters Kerri Panchuk and Jon Prior headed to sunny Forida for the second annual HousingWire’s REthink Symposium recently.
There, they opened their notebooks and found a wide range of interesting topics to write about.
Readers will find plenty of takeaways from a conference that featured outgoing Freddie Mac CEO Charles “Ed” Haldeman; leader of the multistate mortgage servicing investigation, Iowa Attorney General Tom Miller; and internationally known global economist Ian Bremmer.
Gaffney, Panchuk and Prior took copious notes, and share here some of what they learned.
THE FICTION OF STRESS TEST SUCCESS
Paul Miller, managing director of FBR Capital Markets, said the Fed’s recent announcement that U.S. banks passed intensive stress tests is a “type of fiction.”
While Miller doesn’t foresee a shock that could send the Fed back into bank-bailout mode, he noted if a systemic shock were to hit again, the Fed would probably have to provide stability for the banks in the form of liquidity.
On the issue of principal write-downs for GSE mortgages, Miller defended embattled Federal Housing Finance Agency Acting Director Ed DeMarco, saying while some write-downs may be valuable on a situational basis, a large scale principal reduction program would create moral hazard risk for the mortgage finance system.
THE SKEPTIC
After Indiana Attorney General Greg Zoeller told HousingWire in 2011 that the structure of the Consumer Financial Protection Bureau remains a problem, he was nicknamed the “skeptic.”
Fast-forward several months, and Zoeller is doing what all the other AGs are doing — working with the CFPB to focus on consumers impacted by lending issues in their respective states.
Call Zoeller the friendly skeptic. He said he likes CFPB Director Richard Cordray, but he wanted Congress to fix structural issues with the bureau before appointing a chief. With Cordray now in place, the Zoeller and other AGs are moving forward.
When asked about how the AGs settlement could impact investors, Zoeller sympathized with concerns but defended the nation’s AGs, saying at the end of the day, the job of the attorneys general is to focus on protecting consumers.
AGS TO CONSIDER INVESTOR PROTECTIONS IN FORECLOSURE SETTLEMENT
If the top five mortgage servicers begin to abuse bond investors under the foreclosure settlement write-downs, the attorneys general would consider some protections, according to Iowa AG Tom Miller.
Miller faced down banking executives and analysts during a panel at the REthink Symposium. The $25 billion settlement signed in March forces servicers to meet roughly $10 billion in principal reductions, which could swell higher because in some instances the full dollar written down will not be credited.
Servicers will get full credit for reducing principal on loans they hold on their own portfolio but receive 45 cents for every dollar written down on mortgages held in private securities.
“To try principal reduction in a targeted way and find out if it works is good for the housing market,” Miller said. “We know what (the banks’) plans are. Two have said they wouldn’t do write-downs on private securities. But we could have some discussions about something to reassure investors.”
But analysts in the room raised serious concerns in a question-and-answer session afterward. Banks, they said, would abuse the investors and write down principal on bonds wherever they could.
“There should have been a cap or an outright prohibition,” said Amherst Securities analyst Laurie Goodman.
“There wasn’t a cap because the thinking was that it would be a very small amount,” Miller replied. “There are contractual restraints, fears of litigation. Banks have an even greater fear of doing principal reduction on the investors. The banks really don’t want to get into a fight over that.”
NATIONAL HOME PRICES, A FALLACY
One of the best presentations of the conference.
Kyle Lundstedt, who does analytics for LPS, begins his speech on house price indices. He walks to the edge of the stage. Stares out at us. “I’m about to go on a rant.”
He then basically shows how home price indices are useless if taken as a stand-alone barometer for the housing market. California home prices dropped more than 42% since 2006, while Texas prices declined just 2.3%.
So he thought maybe you’d see tighter trends on the MSA level. Nope. San Francisco HPI dropped 35% since the crash. In Sacramento, the drop was nearly 47%.
Digging even to the ZIP code level, there are disparities. One area in Los Angeles showed a price drop of 19%. Across town, in a different ZIP code, prices fell more than 59%.
The conclusion? Throw national home prices out. They don’t exist, he claimed. Monitor the MSAs, he said. Keep an eye on events happening in particular ZIP codes and watch for any signs of that affecting the wider MSA level.
“For God’s sake if you work at a financial institution, fight the power when some says, ‘Tell me what the forecast for home prices is.’ Don’t get sucked into that. We’re always going to be wrong. You’re guaranteed to be wrong. Instead, you have to think about a whole range of outcomes going forward,” he said.
US MORTGAGE INVESTORS LONG FOR THE DANES
A panel of mortgage financiers long for the days when ideas were taken seriously, even simple ones.
Alan Boyce, the CEO of Absalon, a joint venture between Soros and the Danish financial system, has been trying for a long, long time to implement a U.S. mortgage bond market similar to what was set up in Denmark.
He was part of a structured credit panel.
“The 30-year fixed-rate mortgage, that’s callable. The originator takes only the credit risk. They’re prevented from taking interest-rate risk. Their prepays followed S curves unlike ours. An MBS trader can figure out Denmark in an hour. Danish publish everything in real time. We publish every time in a month with a lag. As a mortgage trader here, lags in data delays irked me forever, and I was suspicious when an insider knew a lot more,” Boyce said.
“You want to find that marginal borrower to blend down the callability to get the bonds to trade better, “ Boyce said, which is important. If interest rates fall, and borrowers refinance, they can be taken out of the securities and new loans put into their place. For this, the investor is paid a premium. “The borrowers get the bond market price.”
“QRM got so many people upset, but the Danes can only go to 80% and they have to keep the credit risk. No one freaks out.”
The problem in the U.S. is the erratic structure of state foreclosure laws. “The diversity for enforcing defaults is so widespread, the Danish system would never work. The beauty of Denmark is that it’s been socialized. Everyone knows what the rules are. You pay your loan or you pay if there’s a deficiency judgment.”
He hasn’t given up, but he’s waning. Boyce helped set up a Danish structure in Mexico and he’s visiting Brazil and Peru. He still heads to D.C. every now and then, but not nearly as often.
“In the rest of the world, it’s not much of a sales job,” he said. “There’s only one country that comes up.”
A ‘BROKEN’ HOUSING SUPPLY
“The supply and demand function in housing is broken,” said Laurie Goodman, head of research at Amherst Securities, during her brief presentation.
By her most conservative estimates, there will be between 1.2 million and 1.5 million new distressed housing units generated per year over the next six years, plus roughly 500,000 in new construction. That’s, on the low side, 1.7 million homes added to the supply every year.
Regarding demand, she estimated roughly 600,000 in demand generated from demographics – or 1.2 new household formations with half taking out a mortgage. Obsolescence, or converting homes into some other use, say renting, would take up roughly 400,000 units, and another 200,000 would be purchased as second homes. Goodman said there would be roughly 1.2 million in demand created.
So, again, taking the very conservative 1.7 million supply created from new construction and distressed properties minus the 1.2 million in demand, Goodman says there would be more than 500,000 units added to the market, net of sales, every year for the next six years. Total that up, and the U.S. housing market needs to generate 3.2 million home sales – or demand – over the next six years.
BILL DALLAS: MORTGAGE LENDING REBOOT HINGES ON TECH
Mortgage lending will not return until firms figure out how to better automate an underwriting process overloaded with new rules but still being done by hand, according to entrepreneur Bill Dallas.
Dallas founded First Franklin and is chairman of Diversified Capital, another large mortgage operation. His newest venture is Skyline Mortgage located on the West Coast. Dallas is building out a system that will allow his network of brokers to underwrite mortgages by checking off various compliance issues from new Dodd-Frank provisions to Real Estate Settlement Procedures Act requirements.
“Mortgage lending is not hard any more. There’s one product. Here’s your 30-year fixed. Here’s your rate. When do you want to lock?” Dallas said at the HousingWire REthink Symposium.
The difference now is the compliance. Regulators are no longer satisfied with examining a completed loan, Dallas said. They want to look at every step of the process. Large banks, such as Bank of America and Ally Financial are on their way out. And smaller lenders, usually those most adverse to investing in the technology needed to comply, will have to take their place.
“Whoever has a 70% market share dies,” Dallas said. Nervous laughter ensued in the audience.
There will be plenty of opportunity for growth, he expects. In 2012, he expects $531 billion in purchase mortgages with $400 billion more in refinances. Next year, as interest rates are expected to increase, purchase mortgages could rise to $859 billion with roughly $287 billion in refis, according to his models.
THE MBS INVESTOR AND THE STAFFER
The names of this little episode have been withheld.
There is the investor, who directly manages roughly $40 billion in bonds tacked to mortgages in some way. Then, there is the temporary conference staffer, who was growing curious about all the interesting topics he was overhearing. He cornered said investor, who at first was looking for the car to the airport but paused, intent to listen about the staffer’s horror story.
To sum up, the staffer’s mortgage – originally a 5-year ARM – reset to 12% from 6%.
“That’s insane,” the investor said. “It’s not supposed to go that high. That’s crazy. Are you sure?”
“Uh, yeah, I’m sure. My monthly payment increased by $900. I tried everything, modification, refinance, anything to get the interest rate down just a little bit.”
“What did they do?”
“It was a short sale actually. They sold it for $80,000 less than what I owed, but they waived the deficiency.”
“That’s stupid. That’s just stupid. They could have modified it early on and taken less of a hit.”
When the staffer was asked if the bank disclosed what the interest rate would reset to when he signed the documents, there was a shrug.
“I didn’t look at it. They said to sign here and here. I didn’t know. I thought I was going to be out in five years anyway.”
THE RURAL HOUSING BUBBLE?
According to panelist Rudy Orman, senior vice president of marketing and business development for Residential Credit Solutions, the U.S. Department of Agriculture is fueling a real estate bubble with low-cost, poorly written mortgages on rural homes.
“The credit quality is horrendous. It’s masked by older vintages. It’s an arbitrage. All of sudden you can borrow with Ginnie Mae at 45 bps with a 100 loan-to-value ratio at 115% of median income,” Orman said. “The numbers are gigantic.”
JIM MILLSTEIN: RITUAL SLAUGHTER OF GSES IS NOT THE ANSWER
The public may be calling for the “ritual slaughter of Fannie Mae and Freddie Mac,” but bringing private capital back into the mortgage finance market without some sort of government backstop is “fanciful at best,” according to Jim Millstein, chairman and CEO of Millstein & Co.
Prior to forming Millstein & Co., an investment management and financial advisory firm, Millstein served as chief restructuring officer at the Treasury, where he oversaw the restructuring of American International Group.
Instead of pushing for an abrupt end to the government’s role in the mortgage finance system, Millstein called for an orderly transition and proposed the creation of a new entity, similar to the Federal Deposit Insurance Corp., that would essentially function as a reinsurer protecting taxpayers from the risk. The agency also would take on a regulatory function over the government-sponsored enterprises.
Another step would be to segregate “the mortgage guarantee business from the portfolio business” at the enterprises, Millstein said. His plan would raise guarantee fees to 65 basis points, of which 10 would go to the new reinsurance public agency.
“The balance would then go to Fannie and Freddie to help them accelerate their buildup in capital,” Millstein explained. “When they are adequately capitalized, then you move to privatize the GSEs.”
CHRIS WHALEN AND BILL DALLAS DON’T HOLD BACK ON HOUSING PREDICTIONS
Christopher Whalen, senior managing director of Tangent Capital Partners, is confident home prices will head back downward and he seems to indicate that big banks won’t be able to handle the shock.
Big banks want out of the mortgage business, he said.
“The banks are being really strangled. It’s hard for them to create assets, and their savers have seen income evaporate,” he said. In short, there’s no more money in mortgages at these interest-rate levels.
But there is a great deal of risk, primarily in compliance and burdensome regulation, something banks can’t monetize. Private-label securitization is “running off with no new net origination,” Whalen said, adding the state of real estate lending makes him feel depressed.
Earlier, speaker Bill Dallas of Skyline Financial, a smaller originator in California, said that the opportunity for lenders to originate mortgages is coming soon. “Timing is everything,” he said. “Mortgages will soon be able to be commoditized.”
The one question overhanging the conference is who will pay for the financing of these mortgages. Dallas uses institutional investors, but adds that real estate investment trusts won’t likely become a force in originations. He said legacy assets would continue to dominate activities at the big banks.
IAN BREMMER: POWER SHIFTING FROM DEBTOR STATES TO CREDITOR NATIONS
The global economy is experiencing an extensive and redefining power shift with China leading the way, said Ian Bremmer, the CEO of Eurasia Group.
Financial markets will continue to collapse, however, if players within those spaces do not adapt.
“China will become the world’s largest economy in the next 10 years,” said Bremmer, “but it will still be a poor country.”
Bremmer said that nations with money, regardless of interior makeup, will control the global financial infrastructure.
Unlike the United States after the World War II, financial powerhouses such as Russia and India lack the will or desire to create a financial guiding light.
Bremmer added this lack of leadership from so-called G-classed nations, “a G-Zero world.”
Wars will become more financial in nature, he predicted, especially over precious resources, such as oil.
“The big oil producers are quite stable,” Bremmer pointed out. Europe, on the other hand, appears to be on a dual track, where countries with stronger economies push influence in countries with weak economies.
“Leaders in Greece and Italy are being appointed by Brussels,” he said, “it’s not fair, it’s not democratic, but that’s where it’s going.”
FREDDIE CEO SIGNALS GSE PRINCIPAL REDUCTION COULD BE SOON
Freddie Mac CEO Charles “Ed” Haldeman gave a strong signal that new incentives from the Treasury Department may be enough to start principal reduction on mortgages backed by the government-sponsored enterprises.
In January, the Treasury said it would triple incentive payments to mortgage investors who allow principal reduction in Home Affordable Modification Program workouts. The payouts ranged between six and 21 cents to the investors for each dollar forgiven under HAMP, but that will grow to between 18 and 63 cents.
“I have to say recently the Treasury sweetened the program and tremendously increased the incentive payments in their offer to us,” Haldeman said. “We will reevaluate that to see what may be in our economic best interest. If there are very large incentive payments — which could be 50% of what you could write down — it may be in our economic self-interest to participate in that.”
There are currently 11.1 million borrowers who owe more on their mortgage than the house is worth, according to CoreLogic. Of that, estimates show roughly 3.3 million of those mortgages belong to Fannie and Freddie.
The GSEs and their regulator, the Federal Housing Finance Agency, long shunned principal reduction. Their biggest fear is moral hazard — that borrowers who are still current on their underwater loan would strategically default in order to get principal written down.
“We thought principal reduction could have unintended, secondary consequences on other borrowers seeking the same kind of reduction,” Haldeman said.
One previous analysis showed the GSEs would take significant credit losses if a wide-scale program was put in place. A new analysis from the FHFA, which would cover the new HAMP incentives, is expected to be released in the coming weeks.
NPR and ProPublica reported the analysis will show a reversal, that principal reduction will work for the GSEs under the new version of HAMP.
“As we complete the review, the public should understand that Fannie Mae and Freddie Mac continue to offer a broad array of assistance to troubled borrowers and have continued to implement HARP 2.0 to enhance refinancing opportunities for underwater borrowers,” FHFA said in a statement.
Treasury Secretary Timothy Geithner told a House panel he and FHFA Acting Director Edward DeMarco were working out their differences.
Haldeman, who announced in October he would leave his post at Freddie, said the principal reduction verdict will ultimately reside with DeMarco, but he isn’t operating on his own.
“At the end of the day, we are in conservatorship, and he is the conservator. But the way it works on a day-to-day basis is that it’s a very close collaboration. It is extremely rare that I had a different point of view than Ed DeMarco,” Haldeman said.
CONGRESS TAKES A HIT
Freddie Mac CEO Charles “Ed” Haldeman is not happy with Congress’ priorities. The GSE CEO said Congress’ had misplaced priorities when pulling him in front of House and Senate panels to testify.
Haldeman said the two times he testified, the subject matter was mostly unrelated to the big issues facing Fannie and Freddie, as well as the housing market. One session ended up focusing on executive compensation at Freddie, and lawmakers at another questioning session honed in on the fact that Freddie sent employees to a Mortgage Bankers Association conference to help them connect with clients.
Haldeman expressed frustration with Congress’ limited focus, saying he would have preferred in depth discussions with lawmakers on the future of the GSEs and how the process of ending conservatorship of the GSEs will evolve. Haldeman also pointed out that at the time he was pinged for compensation and the MBA conference, the GSE had already cut millions from its general expenses.
NEGATIVE EQUITY GAP NEARS $4 TRILLION
The U.S. housing market contains a nearly $4 trillion negative equity hole, according to Williams Emmons, an economist with the Federal Reserve Bank of St. Louis.
The Fed Bank economist said it would take $3.7 trillion, much more than the $25 billion mortgage servicing settlement and other federal housing initiatives, to get homeowners with mortgage debt back to preferred loan-to-value ratio levels.
Emmons’ data estimates the average LTV for those with mortgage debt is currently 94.3%.
That compares to preferred LTV levels among mortgage debt holders of 58.4%, which was the average among mortgaged homeowners in the period stretching from 1970 to 2005. Emmons told the crowd there is no easy way to fill that gap, and the deep hole is hardly discussed among the media and policymakers.
“We are sort of stuck in this,” he told the crowd. “It’s a sweat box we’re in, and we can’t get out. We are not talking about this very much … it’s just too ugly.”
He added, “It is like the debt that is outstanding is crushing the equity that is there.”
Emmons said the only viable option to narrow the gap is letting home prices fall until they eventually reach levels that entice buyers, bringing private capital back in.
A home-price boom or a government bailout would help, of course, but both those scenarios are unlikely.
At this point, home price appreciation would need to rise 62% to narrow the gap to the ideal LTV level, Emmons said. Significant government intervention also is unlikely given the fact it would take a $3.7 trillion bailout, or 24% of GDP, to narrow the gap, according to Emmons’ data.
He says that amount makes other federal initiatives launched to Band-Aid the housing market so far look like “peanuts” in comparison.
With that in mind, the only alternative is that we have “millions of weak homeowners exit, replaced by new private owners with equity to recapitalize the housing sector.”
Emmons said that option will still be painful since he believes another reduction in home prices is needed to attract new buyers.
Kerri Panchuk and Jacob Gaffney contributed to this report.
