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Conservator’s Report: A Different View of the GSE’s Demise

by devteam August 30th, 2010 | Share

The firstrnConservator's Report on the Enterprises' Financial Performance issued by thernFederal Housing Finance Agency on Thursday makes an argument that thernGovernment Sponsored Enterprises' role in the housing market was and still is vital.  It also paints a picture ofrntheir fall prior to being placed in federal conservatorship in the fall ofrn2008.  Some observers are alreadyrnpointing to it as a map for the eventual reorganization of the two governmentrnsponsored enterprises.  Another way ofrnviewing the report is that is presents a strong argument for leaving the GSEs in charge.</p

According to thernreport, in 2003, 62 percent of all mortgages originated in the country werernconventional/conforming loans.  Anotherrn20 percent or so were FHA or jumbo loans; only 8 percent were subprime andrnAlt-A loans were virtually non-existent. rnBy 2006 the conventional loan share had dropped to 33 percent whilernsubprime loans had ballooned to 20 percent and Alt-A represented 13 percent ofrnthe market and the Home Equity share of the pie had more than doubled to 14rnpercent.   During this same period the Enterprise's sharernof the MBA market literally fell off a cliff. rn</p

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In 2003 the combined enterprises issued over two-thirds of the almostrn$300 billion MBS volume, in 2004, the volume dropped dramatically to under $200rnbillion and the Enterprises had ceded over half of that to privaternissuers.  When the size of the marketrnshot back up in 2005, it was the private market driving it; the Enterprisesrnparticipation remained relatively flat.  Accordingrnto the report, the Enterprises were guaranteeing primarily traditionalrnmortgages while the private market took the lead in securitizing higher-riskrnproducts.  It is no coincidence that therntrouble began when the Enterprises no longer dominated the market. </p

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When the crash came,rnhowever, Freddie and Fannie were among the early casualties.  The report indicates that the cause of their collapsernwas apparently different from what has been popularly reported.  </p

At the end of 2007, the GSEs had combinedrncapital of $71 billion (Fannie Mae $44b, Freddie Mac $27b).  From that point through the end of lastrnquarter the two have suffered capital reductions totaling $225 billion (Fannie,rn$136b; Freddie $90b).  However, the bulkrnof the losses, $166 billion ($109b & $58b) came from the Enterprises'rnSingle Family Credit Guarantee segment. rnThis is 73 percent of the capital reduction to date.</p

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This is particularlyrninteresting in light of the frequent and loud warnings circa 2005 to 2007 fromrnFederal Reserve Chairman Alan Greenspan and others about the dangers of thernlarge investment portfolios owned by the Enterprises.  In the portfolio segment of their businesses,rnthey bought and held mortgage securities, some of which were guaranteed andrnsome of which weren't; these portfolios ultimately accounted for $21 billion orrn9 percent of the capital reduction.  </p

Since thernconservatorship began in 2008, the mortgage market has swung back to the modelrnthat existed pre-2003, with 63 percent represented by conforming/conventionalrnloans and FHA absorbing a large share of the remaining market;  Alt-A, Subprime, and home equity loans havernvirtually ceased to exist, and the private MBA market has alsorndisappeared.  The Enterprises and GinniernMae are now almost the entire market, which is itself shrunken to around $100rnbillion in volume.</p

The source of creditrnlosses suffered by the Enterprises are disproportionately concentrated in loansrnoriginated in 2006 and 2007, but they are even more heavily skewed toward Alt-Arnloans and interest only loans and to loans written in four states – California,rnFlorida, Arizona, and Nevada.  While thernunpaid principal balance of loans in those states is only 27 percent of FanniernMae's Single Family Book of Business and 25 percent of Freddie Mac's, thosernstates account for 49 percent of the Fannie's 2008 vintage loans and 58 percentrnof the 2009 vintage and for Freddie, 53 percent and 64 percent respectively.rnAlt-A and interest-only loans represent 19 percent of each Enterprise's Book,rnbut between 73 and 100 percent of the delinquent loans. </p

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With the Enterprisesrnand FHA virtually the only game in town, the conservators have been able torninsist on strengthened underwriting, and are now touting the safety of thernnewest loans it has acquired or guaranteed. The current loan profile is quiterndifferent than it was pre-conservatorship.  For example, around 20 percent of the loansrnacquired by the Enterprises in 2006 were Alt-A and 15-17 percent were interestrnonly.  Today those two loan typesrncombined are around 1 percent of Freddie and Fannie's single familyrnbusiness.  The average LTV of a new loanrnin 2006 was 73 percent; today it is 69-70 percent.  The average credit score in 2006 was underrn720, today it is over 750.</p

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While these loansrnare still young, there are some promising indications of their safety.  For example, loans originated in 2007 had arndelinquency rate of 22.29 percent by midway through the second year following origination.  The 2008 vintage loans had a 13.65 rate atrnthe same point in the lifecycle, while loans written in 2009 are running a 1.07rndelinquency rate. </p

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Regardless of thernform the Enterprises take under eventual reform, it appears that their rolernshould return to what it had traditionally been; a virtual gatekeeper for thernindustry.  At the recent “Future of Housing Finance” conferece, hosted by the Obama Administration, Treasury Secretary Timothy Geithner was quoted saying there would be a “wind down” of the Enterprises' portfolios, but, “There is a strong case to be made for a carefully designedrnguarantee in a reformed system, with the objective of providing a measure ofrnstability in access to mortgages, even in future economic downturns.”

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About the Author

devteam

Steven A Feinberg (@CPAsteve) of Appletree Business Services LLC, is a PASBA member accountant located in Londonderry, New Hampshire.

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