Smaller mortgage lenders wary over privatization of Frannie

Community banks and credit unions fear the approaching elimination of Fannie Mae and Freddie Mac (collectively referred to as Frannie) will weaken smaller entities’ roles in the secondary mortgage market.

The anticipated absence of Frannie as the largest purchaser of secondary mortgages will result in a paradigm shift in the secondary mortgage market. The Administration has suggested the possibility of introducing a new government agency that will continue to insure mortgages in some capacity, like the FHA now does, the exact functioning of which is still to be determined. In the meantime, Frannie has begun enforcing more conservative loan limits and raising guarantee fees in an effort to encourage private investors to fill the void.

Smaller lenders fear the absence of Frannie will result in the monopolization of the industry by financial heavyweights. Thus, they object to absolute privatization of mortgages since the complete removal of government guarantees may allow larger lenders (read: Wall Street Bankers) to purchase their own mortgage originations exclusively. That, if it came about, would deprive smaller community banks and credit unions of investors to buy their mortgage originations and free up their capital to offer more loans, effectually stunting smaller lending companies.

Whatever source rises as the next great buyer in the secondary mortgage market, the removal of Frannie and its volume of government-insured mortgages will result in more stringent lending practices than experienced in recent decades. Private mortgage investors without government guarantees will prove cautious and require mortgages with less risky terms, larger down payments and higher risk premium rates as surety for their investments.

first tuesday take: It’s so tough to wean lenders.

Mortgage bankers’ complaint is the possible obsolescence of the practice of warehousing loans and other harmful mortgage practices. In the 1960s and 1970s, these same very small lenders and non-institutional mortgage banking operations lent to homeowners until their capital was completely invested. They then turned around and sold off the warehoused mortgages to replenish their capital to lend to a whole new batch of homebuyers, and so on.

After getting burnt, lenders eventually figured out the risks of interest rate changes in the market, but they did that in the exercise of business judgment. Government guarantees then came along (under the first Romney and Nixon) and commenced to shift this risk to the government (with rather bad results even then).

Thus, increased privatization of the secondary mortgage market will bring more relief than cause for trepidation to these same community banks and credit unions of forty/fifty years past. Better yet, without government entities to guarantee mortgages, actual management of more responsible requirements for qualifying home loans will result. In turn, the relationship between borrowers and lenders will stabilize. The end result is a return to fundamentals, which is ultimately a good thing for everyone.

The traditional minimum 20% down payment requires borrowers to have more skin in the game — inspiring a more thoughtful approach to the considerable commitment of family and money to buying a house as shelter, not as an opportunity to reap a profit.  With that financial commitment, borrowers effectively anchor themselves to that property and its location for the long haul.

The presence of equity in their real estate also causes default to be a less probable threat to lenders, simultaneously reducing the necessity for government guarantees. [For more information on the benefits of conservative loan practices, see March 2011 first tuesday article, Some dread the demise of Fannie and Freddie.]

However, Frannie is not the only guarantor of home loans wrestling for a piece of the secondary market; Private Mortgage Insurers (PMIs) provide coverage to limit a mortgage lender’s risk of lending to homeowners.  PMIs function to mitigate most of the risk that will result from a withdrawal of government guarantees. [For more information on PMIs’ ability to fill Frannie’s shoes, see March 2011 first tuesday article, Mortgage market reform from the executive branch.]

PMIs may not have the capacity to insure mortgages at the premium rates lenders hope for, but then neither did Frannie. Frannie’s extinction may be an uncomfortable reality check for lenders who came to be dependent on them, but will force these lenders to form more enduring mortgage arrangements with sustainability in mind, not just a quick buck.

As borrowers and lenders alike have learned, abstractedly parceling out more and more mortgages to extend lending companies beyond their practical limits inevitably results in a backlash. It’s a matter of financial gravity.  Perhaps a private safety net for loans in the secondary mortgage market to cover defaults on riskier mortgages will cause lenders to be more concerned with conducting business within their means – like borrowers, having their own skin in the game.

 The alternative at this point is the perpetuating of ever shakier mortgage investments as was increasingly allowed by government and designed by Wall Street Bankers during the past 30 years – particularly those last few leading up to the crash.

Re: “Community banks and credit unions brace for end of Fannie, Freddie” from the Washington Post