SAN FRANCISCO — Fannie Mae and Freddie Mac are shifting their emphasis from earning the maximum return for investors to pricing their loan guarantees to provide maximum liquidity to mortgage markets while still maintaining minimum safety and soundness standards.
That, coupled with the government’s backing of Fannie and Freddie’s debt and mortgage-backed securities, could help drive down interest rates in coming months, according to the newly appointed top executives at Fannie and Freddie and the head of the federal agency that oversees them.
During a panel discussion today at the Mortgage Bankers Association’s annual meeting, the three policymakers said that in addition to canceling fee increases originally planned for this month, Fannie and Freddie are in the process of reevaluating pricing of their loan guarantees and engaging in a concerted effort to keep existing borrowers out of foreclosure.
"This is a very challenging time," said Fannie Mae Chief Executive Officer Herb Allison. "We’re totally open to revising and even discarding practices and habits and traditions we’ve had in the past. We’re looking at everything we do to see how we can serve you and more importantly the American public better."
Fannie Mae this month rescinded a plan to increase an adverse market delivery charge from 0.25 percent to 0.5 percent, and Freddie Mac has done the same. Freddie Mac had followed the lead of Fannie Mae in August in announcing that it would double delivery fees charged on all loans in response to mounting losses — the increase would have resulted in fee increases equivalent to $1,000 on a $200,000 mortgage (see story).
Allison said further pricing changes could be in store, as Fannie’s management looks at the company’s required return on capital, and instead of focusing on maximum return on capital, focuses on the minimum return required to ensure safety and soundness.
Freddie Mac’s new top executive, David Moffett, made similar promises, saying the company is rethinking the risk-return tradeoff in terms of borrower’s capacity to pay, their credit history, and collateral, and how those factors impact Freddie’s losses and pricing.
Freddie Mac is going back to the basics, reexamining every aspect of our business," Moffett said, with a goal of providing a "sustainable model" for providing liquidity to both single-family and multi-family mortgage markets.
Technology will play a "significant role" in improving the quality of service to mortgage lenders, Moffett said. Freddie Mac is looking at ways to improve efficiency and volume, and to eliminate obstacles to getting mortgage-backed securities into the marketplace.
"I’ve asked our operations people to take a white piece of paper out and improve the process from beginning to end" rather than make incremental improvements to the existing process, Moffett said.
Since Fannie and Freddie were placed under conservatorship by the government in September, James Lockhart, director of the Federal Housing Finance Agency, has had a bigger say in how the companies are run.
During the boom, "There’s really no doubt that the pendulum swung much too wide on taking risk, that underwriting standards fell, and risky mortgages were made," Lockhart said. "Now we need to take action to make sure the pendulum doesn’t swing too far the other way."
But one thing Lockhart doesn’t control is how much secondary market investors are willing to pay for mortgage-backed securities guaranteed by Fannie and Freddie, or debt issued by the companies. A lack of investor confidence in Fannie and Freddie — or the perception that other comparable investments like Treasurys offer a better risk-return ratio — can push mortgage interest rates up.
Interest rates for mortgages eligible for purchase by Fannie and Freddie initially dropped below 6 percent after the government took the companies over and the Treasury was authorized to invest up to $100 billion in each. But rates have bounced back up in recent weeks, in part because the credit crisis has kept the "spread" between Fannie and Freddie’s debt and mortgage-backed securities elevated in comparison to Treasurys of comparable maturity.
That makes little sense to some observers, since the government now stands behind Fannie and Freddie’s debt and mortgage-backed securities. Lockhart said it’s only a matter of time before investors comprehend the extent of the government’s backing of Fannie and Freddie, and markets respond. When that happens, he said, the spread between mortgage-backed securities and Treasuries should shrink, bringing mortgage rates down.
"My hope is markets will see the strength of the government’s support," Lockhart said. "If people start to understand what’s going on, we’ll start to see mortgage rates come down again."
Allison, now entering his seventh week as Fannie Mae’s top executive, agreed.
"Markets are trying to sort it out," he said. "I think (the current wide spreads) are a temporary phenomenon — I think spreads will return to more normal levels over time."
But even if the spread between Treasuries and Fannie and Freddie’s debt and securities comes down, mortgage rates could still rise if the government’s plan to borrow $700 billion to recapitalize banks and buy up "toxic" assets floods the market with Treasuries and drives long-term interest rates up.
"There is a lot of fear that this supply of capital being thrown at the market in the form of Treasury bonds will hold mortgage rates higher than they should be," said moderator Ron Insana, a former journalist and CNBC analyst.
Insana wondered if the government might end up having to buy long-term Treasuries to keep interest rates down, as was done during the Kennedy and Clinton administrations.
Lockhart said that’s a decision the Treasury Department would ultimately have to make. Government intervention is still in its early stages, and "We’re going to let the dust settle and see how markets react," he said.
Insana also wanted Lockhart’s view on whether the entire $700 billion Treasury rescue program will now be spent to recapitalize banks, as Sen. Chris Dodd, D-Conn., has suggested. The program was originally pitched as a means of buying private label mortgage-backed securities and other troubled assets from banks and financial institutions.
So far, the government has set aside $250 billion to recapitalize banks by purchasing preferred stock. But if the entire $700 billion was earmarked for recapitalizing banks, that could result in $7 trillion in additional lending, Insana said.
Some real estate industry trade groups, like the National Association of Realtors, say the government should not abandon plans to buy up mortgage-backed securities and whole mortgages, saying that could reduce foreclosures.
Lockhart said it’s his understanding that the Treasury will follow through with plans to buy up troubled assets, including mortgage-backed securities and whole mortgage loans, and that it was his hope the program would begin soon.
Although the government will have a good deal of freedom to direct loan servicers to engage in workouts with borrowers when it purchases whole loans, the process will be more cumbersome when it buys an interest in complex securities that are carved up in "tranches" of varying degrees of risk. The rules governing workouts are often governed by the trusts that may limit the way workouts can be conducted.
But Fannie and Freddie have considerable leeway to engage in workouts and loan modifications with troubled borrowers on mortgages they guarantee or own, and are stepping up efforts to do so, Allison and Moffett said.
About 40 protestors gathered outside the convention, and the panel discussion was interrupted by a woman who jumped on stage and demanded a moratorium on foreclosures.
"I can’t describe the amount of human effort (that is going into) foreclosure prevention," Moffett said. Employees are spending long hours and weekends trying to resolve foreclosures, he said.
"We are continuing to find new ways to solve the foreclosure problem, and we have not run out of ideas," he said. Freddie Mac is "working hard with our master servicers to keep people in their homes."
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