Mortgage finance overhaul begins to take shape
Thursday, February 10, 2011; 8:13 PM
The Obama administration is pushing ahead with a vast rewrite of the rules of the nation's mortgage market separately from the delicate task of devising options to abolish mortgage finance giants Fannie Mae and Freddie Mac.
In a long-awaited report Friday on the future of home loans, the administration will address both efforts. Much of the focus is expected to be on determining the future of Fannie and Freddie, which rely on a massive taxpayer bailout to prop up the mortgage market.
But perhaps equally important will be measures to protect borrowers against taking on loans they can't afford, draw private firms back into the mortgage finance business and prevent excessive risk-taking by financial companies.
The question of Fannie and Freddie's future could become bogged down in partisan battles on Capitol Hill, but many of the administration's other steps to overhaul mortgage finance need no legislation.
Federal regulators and senior administration officials have been meeting to implement these policies. They view these steps as crucial - regardless of what happens to Fannie and Freddie, according to sources familiar with the matter.
"Inclusion of these proposals in the Treasury's white paper . . . could relieve the political pressure to address" Fannie and Freddie in this session of Congress, Goldman Sachs political analyst Alec Phillips wrote in a memo this week.
Yet even sensible policies raise "big issues," said Susan Wachter, a real estate professor at the Wharton School at the University of Pennsylvania. "At the end of the day, the big question is whether the borrower will have the options to borrow - with a fixed rate mortgage or an adjustable rate mortgage - [that] they have historically had."
The white paper is expected to call for reducing the support given to the housing market by Fannie and Freddie as well as the Federal Housing Administration, which backs low-down-payment loans for first-time homebuyers. Today, these provide the support for more than nine in 10 new home loans, and the administration would like to make it easier for banks to take over the role these government agencies are playing. The report is expected to offer options to eliminate Fannie and Freddie, either with a new government insurance program for mortgages, or nothing at all.
But separate from proposing how to eliminate Fannie and Freddie, the Obama administration for now is working with the Federal Housing Finance Agency, Fannie and Freddie's regulator, to increase the fees the firms charge to insure loans, thereby increasing the rates of the mortgages backed by these companies. That could open the opportunity for private firms to compete on price. The tactic does not require legislation.
Meanwhile, the FHA is contemplating increasing its required minimum down payment from 3.5 percent to 5 percent over time, which would likewise make the agency's loans less appealing than what private firms could offer. This would require congressional approval. The FHA is also considering increasing the annual fees it charges borrowers by a quarter of a point.
Taken together, these measures would directly affect borrowers, by increasing the costs of buying a home. That would also make the loans more profitable and perhaps draw new competition from private firms.
Other measures being pursued by federal banking regulators are aimed at reviving the markets where mortgages are pooled into investments and sold worldwide. The ability to sell mortgages to global investors provides financing for lenders to issue mortgages.
At the same time, regulators want to cut back on the type of excessive risk-taking that helped lead to the financial crisis, where banks offered loans to anyone who would take them, bundled the mortgages together into securities and sold them to investors without properly assessing the risk.
Regulators are working on a definition for "Qualified Residential Mortgage," a term referring to a home loan that has a low risk of default. To qualify for that label, lenders might have to require, for instance, a down payment of 20 percent. At the same time, these mortgages would not have to meet onerous new regulations and, as a result, would be cheaper for borrowers.
Such loans would also be free of new requirements that banks retain a financial interest in any mortgage-backed investment they sell. Requiring these firms to have "skin in the game" is expected to make lenders more conservative in their practices.
Other changes underway include easier-to-understand mortgage disclosures from the new Consumer Financial Protection Bureau, and new rules that prohibit lenders from making loans without determining, based on verified documentation, that the consumer can afford the loan.