This article examines a recent report published by the FHFA comparing the risk characteristics and performance of government sponsored entity (GSE) loans vs. private-label mortgage-backed bond (MBB) loans in the financial crisis of late 2008.
In an effort to discern the genesis of the flood of mortgage money that lead to the financial accelerator effect, the momentum of which drove low-tier home prices in California to three times their level between 2000 and 2006, a study was undertaken to assess the culpability of government sponsored enterprises (GSEs) and private-label mortgage-backed bonds (MBBs) —Wall Street bankers— in the financial crisis of late 2008.
Published in a September 2010 Federal Housing Finance Agency (FHFA) news release, the report compares the risk characteristics and performance of mortgage loans financed through the GSEs and private labels. The findings of this study by the Federal Housing Finance Agency (FHFA) were a surprise to those concerned with the more repugnant aspects of GSEs. It now appears that the GSEs played a limited role in the failure of the housing market during the decade spanning the Millennium Boom and the ensuing Great Recession.
The distinguishing features that contribute to the variation in default rates between GSE and private label mortgages looked into by the FHFA include:
Fair Isaac Corporation (FICO) score consideration
84% of conventional single family residence (SFR) mortgages acquired by Fannie and Freddie between 2001 and 2008 were made to borrowers with Fair Isaac Corporation (FICO) scores above 660. Only 5% were made to borrowers with FICO scores below 620.
Conversely, 42% of mortgages financed through private-label MBBs were made to borrowers with FICO scores above 660, while 32% were made to borrowers with FICO scores below 620.
Loan-to-value (LTV) ratios regarding down payments and owner equity positions
82% of SFR mortgages acquired by Fannie and Freddie had LTVs of 80% or less. Mortgages with LTVs greater than 80% but at or less than 90%, and mortgages with LTVs greater than 90% each comprise 9% of all SFR mortgages acquired by Fannie and Freddie between 2001 and 2008, totaling 18% of all their mortgages.
Roughly 66% of SFR mortgages financed through private-label MBBs had LTVs at or below 80%. Mortgages associated with LTVs greater than 80% but at or less than 90% comprised 20% of all mortgages financed through private-label MBBs, while another one-tenth of the mortgages financed through private-label MBBs were associated with LTVs greater than 90%. Thus, 30% of all private-label mortgages had LTVs of 80% or more.
Whether the interest rate was fixed or variable
Of the two basic types of loans originated, 88% of all SFR loans acquired by Fannie and Freddie between 2001 and 2008 were fixed-rate mortgages (FRMs), leaving 12% of their loans as ARMs.
Conversely, 70% of those SFR loans financed through private-label MBBs were adjustable rate mortgages (ARMs).
Mortgage delinquency rates
Approximately 5% of FRMs and 10% of ARMs acquired by Fannie Mae and Freddie Mac were 90-days delinquent at some point before 2009.
By contrast, approximately 20% of FRMs and 30% of ARMs financed through private-label MBBs were 90-days delinquent by the end of 2009 — three to four times riskier than GSE mortgages.
The data here affirm the GSEs were not as culpable for accelerating the implosion of the real estate market to its boom-time peak before the implosion, as many have argued.
The popular understanding of the lower LTVs, higher credit scores and lower delinquency rates associated with GSE loans is that they are a direct result of the hefty regulations imposed on Fannie and Freddie after they were brought under government conservatorship in 2008. This is not so. Although federal regulations for conforming loans have certainly added to the integrity of Fannie and Freddie’s portfolios, the data released by the FHFA vividly demonstrates that mortgage origination integrity has been part of a more long-term trend.
Actually, Fannie and Freddie did not start financing subprime mortgages until 2006, which was one year after origination and home sale volume peaked and at the time prices had started to decline.
Two years after the bubble burst, some people insist on looking backwards, trying to assign blame for the housing market crash. Rather than pointing fingers, or shirking responsibility, the energies of brokers and agents as the gatekeepers to California’s real estate need to be focused on regenerating the current real estate market based on where we are, what we have to work with, and restructure it to operate openly and sustainably. Let the optimists among us step forward, survey the landscape and begin innovating. [For more information on the new real estate paradigm, see the May 2010 first tuesday article, Looking through the window towards recovery: a real estate paradigm shift.]