June 30, 2013

Ticking Time Bombs Of Moral Hazard

Readers suggested a topic on the GSE’s. “How about a topic on Fannie and Freddie - their planned demise, what is going to end up taking their place, is there the slightest chance that nothing will take their place, etc. I’m pasting this from the NYT. Don’t ususally post entire articles, but I can’t figure out how to cut this one. It is largely about what is being considered for now, not what should be considered, but it is still very interesting. And it raises the issue of the entire idea of whether the availability of 30 year fixed mortgages should be a policy or not.”

One said, “I read a different article on this, and one question I have is whether the new government insurance will also cover NEW apartment loans. The article I read noted that they would continue to guarantee existing apartment loans. If you really want to see the affect of rising rates, you should look no farther than multifamily and multifamily cap rates. Cap rates (yields) are currently at remarkably low levels, and rents have nearly fully recovered in many places. The combination of the two have resulted in apartment values being at VERY high levels…driven substantially by low financing rates that are available…through the good graces of the FHA and Fannie/Freddie.”

“An estimate that I’ve heard is that if Fannie/Freddie were to go away tomorrow, that interest rates and cap rates for apartments would rise by 1% overnight…if your starting point is a 5% cap (infill So Cal commonly sees these cap rates), a 1% rise reduces your value by 17%. AND if we are in the context of a rising rate environment generally, cap rates could rise even further. The only option for the apartment owner is to raise rents to try to make up this difference…and at today’s home prices, that would simply tend to push more renters to buy.”

A reply, “If an ‘expert’ sez it, then it must be true…at least at bubblelicious price levels which reflect subsidized insurance! A politician tells a NY Times journalist that the private market cannot possibly take over the role of the GSEs, and suddenly the laws of economics are repealed.”

And finally, “Given the ‘time bomb’ of maintenance costs a 30 year mortgage is an accident waiting to happen. 15 year should be the norm - maybe 20 years for new construction. Or maybe not as lumber is not as good now as in years past.”

Investor’s Business Daily. “Can Washington stay in the mortgage game without putting the taxpayers at risk once again? Some senators think so, but there’s reason to be skeptical. No one ever said it would be easy to replace Fannie Mae and Freddie Mac. The two hold some $5 trillion in mortgages. That’s a lot to unwind.”

“If worse comes to worst, the taxpayer is still there to absorb the losses. That’s a big problem for two reasons. One is that any taxpayer backup invites overly risky behavior — as happened with Fannie and Freddie. The other reason is that the real estate, banking and construction lobbies will do all they can to make the limited government role less so. This lobby tends to get (and keep) what it wants. Witness the continued sacred-cow status of the mortgage-interest deduction and the continued survival of Fannie and Freddie themselves.”

“The big question is whether this smaller federal ‘footprint’ stays small. Our guess is that it would morph under political pressure into something like the Fannie and Freddie we have today — too-big-to-fail monsters that, profitable for the present, are ticking time bombs of moral hazard in the long run.”

US New & World Report. “According to the National Association of Realtors, only 15 to 20 percent of the homes that were foreclosed on during the downturn were making their way to the market in 2008 and 2009. The remaining 80 to 85 percent of the homes were bought back at foreclosure and are now owned by the banks. One might ask why the banks would want to own these properties. The answer is both telling and very scary.”

“Current bank regulations do not require the banks to ‘mark-to-market’ their real estate holdings. Bank management, therefore, would rather continue to book an inflated real estate value and pay the debt service and management costs to hold the property rather than sell the property and book the losses. This is why some markets have no inventory, why banks are still hesitant to lend money and why we are not free from the issues we created in the U.S. and globally by overextending our leverage.”

“We have seen a decline in this inventory of about 35 percent from the peak in 2010, however, the last quarter saw a fairly dramatic increase of 9 percent. So which way is the pendulum swinging next? In April of 2012, the finalization of the national mortgage settlement clarified acceptable foreclosure processing procedures giving the banks better ability to effectively foreclose and avoid a lengthy court process. We have seen a rise from $175 billion to $205 billion in the estimated value of the shadow inventory and I am guessing there is more to come.”

The Lake Spokane Outpost. “HomePath®.com is the official website owned by Fannie Mae on which they post information about all their foreclosed homes for sale and any special financing terms. You can use any type of mortgage to purchase a Fannie foreclosure, but the special HomePath® financing can only be used to purchase Fannie Mae owned homes.”

“Why use the HomePath® loan instead of a regular Conventional, FHA, VA, or USDA? There are two very significant advantages to using this special program. First, the appraisal is waived which saves you about $500 and shaves at least 5 days off the escrow process. And with no appraisal there is no fear of the appraised value coming in less than the sales price and jeopardizing the entire transaction.”

“Second, there is no mortgage insurance required when putting less than 20% down. While many people chose to put as little down as possible this feature is particularly beneficial to first time home buyers who might not have saved up a large down payment. The monthly cost of mortgage insurance can easily be $150 or more (the actual amount depends upon loan amount and your FICO score). Not having to pay that equates to about $20,000 extra in house price you can afford.”

“In addition, the private mortgage insurance companies are very restrictive on their approval of applicants. Avoiding this hurdle opens up home ownership to many families who would not have met the requirements for mortgage insurance had they chosen a standard loan instead of using HomePath®. Even investors are allowed on this program – you can buy the home as a rental with 15% down and no mortgage insurance.”

Bits Bucket for June 30, 2013

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