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2016-11-15 19:33:13
Fannie and Freddie’s Status Continues to Provoke Criticisms

The presidential campaign that just ended was notable for a lack of debate about housing — in particular the uneven state of the United States mortgage market nine years since the start of the financial crisis.

Neither President-elect Donald J. Trump nor Hillary Clinton spent much time discussing housing policy, even though the financial crisis in the United States began with the collapse of home prices nationally. And neither candidate laid out a plan for dealing with the two biggest engines in the mortgage market — Fannie Mae and Freddie Mac — which remain under a controversial federal government conservatorship.

Laurie Goodman, a longtime housing industry guru on Wall Street and now with a Washington research organization, said she did not think federal legislators would make it a priority to address the fates of Fannie and Freddie — two government-sponsored entities that were rescued by the Treasury eight years ago with a $187 billion taxpayer bailout.

“I am very pessimistic on G.S.E. reform,” said Ms. Goodman, co-director of the Housing Finance Policy Center at the Urban Institute, referring to the government-sponsored enterprises, as Fannie and Freddie are known. “I don’t see the impetus for change.”

She is not alone.

There is a growing sense among housing policy experts that it may take another crisis — a recession or more big losses at the mortgage giants — to get the new president and Congress to come up with a more permanent way to handle the responsibilities now shouldered by Fannie and Freddie. Until then, it is very likely that both agencies will go on in a state of limbo: run by their own management teams, but with strict oversight by the relatively new Federal Housing Finance Agency.

A handful of plans have been proposed for reforming Fannie and Freddie, the agencies whose prime responsibilities are to effectively guarantee 30-year mortgages, which are packaged into bonds. But none of those proposals have galvanized widespread support from legislators or the financial community, so the current unpopular conservatorship has been permitted to go on and on.

Some favor merging Fannie and Freddie into a single entity, while others want to turn them into a government-run housing finance corporation — a mortgage finance utility of sorts. Others want to replace them with a number of smaller independent firms that will guarantee mortgages against default and maintain hefty regulatory oversight.

And still others, mainly investors owning shares in Fannie and Freddie, want to see them recapitalized, set free and returned to the public markets as independent companies with minimal government control.

“People want to preserve the 30-year mortgage, they want private capital and they want to preserve a role for the small lender,” said Ms. Goodman.

But there is little consensus on what kind of ownership structure should prevail to achieve those goals. Ms. Goodman said gridlock and inertia were bad because they discourage innovation in the marketplace, which could make mortgages more widely available to consumers.

Also, she said, there is the potential for Fannie and Freddie to become more “politicized” the longer they remain in conservatorship and de facto agents of the Treasury.

Fannie Mae and Freddie Mac got into hot water because they took on too much risk in the time leading up to the financial crisis.

The companies, which were chartered by the federal government, operated as independent companies and largely made their own decisions about which 30-year mortgages to buy and guarantee against default.

For decades, both entities were largely conservative about which mortgages to guarantee or buy for their own investment portfolios. But over time both became more aggressive in buying loans that turned out to be risky but were not considered traditional subprime loans at the time. The companies saw the value of those investments plummet when the housing market collapsed.

The bailouts of both companies in September 2008 were viewed as a critical step to prevent an even greater financial calamity. But the conservatorship has grown controversial over time, particularly given that hedge funds and other investors continue to own shares in both of them.

Over the last four years, as the economy has revived and much of the housing market has recovered, Fannie and Freddie began paying dividends to the federal government, leaving little behind for the company’s private shareholders.

To date, Fannie and Freddie have paid more than $250 billion in dividends to the federal government. The bailout has generated a profit for the Treasury.

The fiercest critics of the conservatorship want Fannie and Freddie to keep much of any additional dividend payments and return to the public markets as independent entities — much like the way they operated before.

Some hedge funds and institutional investors have sued the federal government over this issue, claiming it has deprived private investors of billions of dollars in potential profit by taking all the dividends paid out by Fannie and Freddie.

The hedge funds and investors contend that the federal government is effectively profiting from the conservatorship at the expense of private shareholders.

“It is frustrating these entities have been in conservatorship for eight years,” said Tim Pagliara, chairman and chief executive of CapWealth Advisors, who heads a coalition of investors in Fannie and Freddie called Investors Unite. “It’s like a cake that’s been mixed and been refined, and all you have to do is add capital and put them back out because nothing else has worked.”

Mr. Pagliara’s organization regularly sends out news alerts to the media criticizing the conservatorship and the Treasury for continuing to take in dividends from the mortgage companies.

Jaret Seiberg, an analyst with the Cowen Washington Research Group, said in a research note on Wednesday that Mr. Trump’s election would most likely “open the door for the government to return Fannie and Freddie to private ownership.” But Mr. Seiberg does not foresee the companies returning “to their former selves.”

Some say that allowing Fannie and Freddie to operate as they did before the crisis might prompt them again to expose the government to guaranteeing too many risky mortgages. The fear is that Fannie and Freddie will return to their old ways of trying to maximize profits at the expense of prudence.

“If they are public companies, that would simply return them to the need to drive profits and increase risk-taking, and that’s what created the problems in the first place,” said Sam Khater, deputy chief economist at CoreLogic, a business analytics company.

Still, finding a permanent fix for Fannie and Freddie will not address another problem confronting the housing market after the financial crisis: a paucity of small-dollar mortgages being underwritten by banks.

Besides loans guaranteed by Fannie or Freddie, big banks have focused much of their lending on what are known as jumbo mortgages, home loans issued to wealthier borrowers with pristine credit histories who are borrowing more than $400,000.

Jumbo mortgages are more profitable and less risky for banks than smaller loans.

But the dynamic has left a huge void in the market for borrowers with limited incomes who are looking to buy a house with a mortgage for less than $100,000.

Nationwide, in 2016, financial institutions operating in the largest metropolitan areas wrote 146,039 mortgages of $100,000 or less as of the end of August, according to CoreLogic. During that same time, lenders underwrote 1,475,637 mortgages of $100,000 or greater.

The percentage of small-dollar mortgages being underwritten by banks is at its lowest level in at least a decade.

The lack of mortgage credit for borrowers seeking smaller loans is a big problem in a troubled city like Detroit.

The Urban Institute reports that the vast majority of homes sold in 2015 in Detroit were bought in all-cash deals. For all of last year, just 653 homes were bought with a mortgage in Detroit.

This lack of small mortgages is helping to fuel a postcrisis revival in Detroit and elsewhere in seller-financed home sales — arrangements known as a contract for deed or a rent-to-own deal.

However, these deals often are lacking in important consumer protections and have a long history of abuse.

Homes sold through a contract for deed or in a rent-to-own transaction are often in need of major repairs.

It is not known how many lower-income consumers are buying homes through a contract for deed because in many states, such as Michigan, there is no requirement for sellers to record such deals until title to the property is ultimately transferred.

But RealtyTrac, a property data service, estimates that on average 20,000 homes a year have been sold nationally through contracts for deed since 2009, and the pace of deals has quickened since the crisis.

“Without these small mortgages, sales evaporate, houses go to investors who have cash on hand, or families opt to use seller financing vehicles,” said the Urban Institute in a recent report penned by Ms. Goodman and others at the organization.