Fannie And Freddie: More Money Needed And A Plan For More Risk

Fannie and Freddie are flying under the radar what with all the other things going on this week but that doesn’t mean there isn’t some news out of them that deserves attention.

First off, the regulator of the two quietly let drop the news that they may need more than $200 billion in additional funding. When the government seize control of them it pledged to invest up to $100 billion in each if necessary. According to James Lockhart, the regulator, the stress tests that were done at that time have proved to be too optimistic and more than the original commitment may be required.

Lockhard also announced that they were looking into the possibility of Fannie and Freddie providing warehouse financing to mortgage originators. Warehouse lenders temporarily finance the accumulation of mortgages by smaller mortgage banking companies. Those mortgages are usually sold in bulk to Fannie and Freddie. It’s an iffy proposal in my mind. My experience is that when interim lenders take themselves out, good underwriting often ends up taking a back seat.

Fannie has announced that it is relaxing its underwriting guidelines for investor loans. They had restricted buyers of one to four family homes to no more than four mortgages. In other words, a home owner that say had one investment property could only come to them and expect to get financing for two more homes. Now they will allow an investor to have up to ten mortgages. Freddie has not followed suit to date, but expect them to do so.

Fannie is obviously looking to investors to help provide some help in taking up the excess inventory on the market. This probably aligns their programs with the realities of the market. Investors have made up a larger percentage of the buyers of foreclosed homes than the press has reported and going forward, demand from owner occupants is probably not going to be sufficient to work off the excess inventories in a reasonable period of time. Two thoughts.

First, conceptually I agree with the change. It simply recognizes a market reality and properly underwritten there is not as much risk as there was at the height of the bubble. So long as the buyer is a knowledgeable investor, the prices in many markets allow for positive cash flow with a moderate amount of leverage. That wasn’t the case during the frenzy when the only profit that could be derived was through price appreciation and resale. Note, I wish to emphasize that this works for knowledgeable investors with a moderate amount of leverage.

But, during the go-go years Fannie, Freddie and all the other lenders had caps on total mortgages. The investors found very quickly that it was almost unenforceable. It takes anywhere from three to six months for a mortgage to hit a credit report so if you can accumulate a number of properties within that time frame, you can easily get around the mortgage cap. You simply don’t disclose the fact that you own or may be in contract for other properties on the loan application and absent that disclosure no evidence is readily available to show the number of properties mortgaged. Not only does this get around the mortgage limit but it also invalidates the underwriting process as debt to income ratios and liquid asset tests are circumvented. There are ways to do more due diligence but it is time consuming.

Just one other thought. While investors will help take up inventory, they also potentially represent a large shadow inventory overhang. As and when prices start to move back up they will naturally want to sell into that market. To some extent they will retard the long term recovery of a healthy market if their presence becomes out-sized.

So pluses and minuses to the idea. Properly administered it’s to my mind positive. Proper administration and underwriting, however, have not been virtues recently associated with the agencies.

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