Housing Finance: “Understand What Broke, Keep What Worked, Discard What Didn’t”
Annaly Capital Management is a real estate investment trust (REIT) that manages a portfolio of adjustable-, floating-, and fixed-rate mortgage-backed securities. The REIT “represents the secondary market investors who have historically provided the majority of the capital to the $11 trillion mortgage market.” In that capacity, he recently provided testimony and documentation to the House Financial Services committee on “The Future of Housing Finance—A Review of Proposals to Address Market Structure and Transition.”
Michael A. J. Farrell is the Chairman and CEO of the firm. He lobs out sharp tongued commentary and critiques of mortgage, securitization and housing related issues in his blog, Annaly Salvos on the Economy and Markets.
I found his overview of the crisis succinct and informative:
“The liquidity that Fannie Mae and Freddie Mac provide, both through their MBS guarantees and through their own balance sheets, has been an important component of this system, and not just for the conforming borrower. Indeed, a conforming borrower has generally paid a lower rate than a jumbo prime borrower, but the conforming mortgage rate also serves as an effective benchmark for other mortgage rates.
It has not been a perfect system, however, and its flaws became most evident beginning in the first decade of this century. These flaws are well‐documented and include (but are not limited to):
• Fannie Mae and Freddie Mac, as private companies with public policy charters, served two masters. They pushed for profitability for shareholders to the detriment of their government charters by increasing their leverage and lowering their own underwriting standards. In the end, they achieved their charter objective, but they failed both masters.
• Mortgage originators ignored prudent underwriting standards and unleashed a flood of affordability products on unwitting and unqualified borrowers.
• Mortgage borrowers misunderstood or ignored the risks of the affordability products.
• The financial engineers on Wall Street created CDO and SIV structures that fed unprecedented demand and embedded leverage on leverage.
• Ratings agencies used flawed models, included perpetual home price appreciation assumptions, to improperly rate the different cash flow tranches.
• Investors in both the senior tranches (including the GSEs) and the junior tranches exercised poor judgment in trusting that others on the assembly line (originators, rating agencies, underwriters) did their jobs responsibly.
• The socialization of credit risk around the globe infected virtually every financial institution.
The key to overhauling housing finance in America is to understand what was broken, then keep what worked and discard what didn’t.
He obviously is not an unbiased participant, but he is knowledgeable, and provide insight. The full PDF is worth reading.
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Source:
Input on Reform of the Housing Finance System
Michael A.J. Farrell, Chairman, Chief Executive Officer and President
Annaly Capital Management, Inc.
U.S. House of Representatives Committee on Financial Services, July 21, 2010
“The Future of Housing Finance—A Review of Proposals to Address Market Structure and Transition”
http://www.annaly.com/Admin/AttachmentFiles/1407.22.10AnnalyCapitalManagementInputonReformoftheHousingFinanceSystemfinal.pdf
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September 29th, 2010 at 12:04 pm
This is just the re-affirmation of established fallacies:
• “Fannie Mae and Freddie Mac pushed for profitability for shareholders to the detriment of their government..”
This is false. Did the shareholders benefit from any of these “profitability”? Truth be told the only beneficiaries were the executive team of both institutions to the detriment of the rest.
• “Mortgage originators ignored prudent underwriting standards and unleashed a flood of affordability products on unwitting and unqualified borrowers.”
Also false if the products were affordable why so many foreclosures? Here again the beneficiaries knew that the products were not affordable and very likely fraudulent.
• The financial engineers on Wall Street created CDO and SIV structures that fed unprecedented demand and embedded leverage on leverage.
Stop calling them engineers it devalues the engineering profession and I find it offensive. The execs of WS firms knew that what they were creating was crap and they did it in detriment of their own firms because it allows them to become very rich in a very short time.
• Ratings agencies used flawed models, included perpetual home price appreciation assumptions, to improperly rate the different cash flow tranches.
False again. Rating agencies sold AAA ratings to highest bidders (WS) because that was the way for them to make money regardless of the quality of loans.
At the end of the day the explanation for what happened is simple once you realize this: State protected fraud across the credit industry and it will happen again.
September 29th, 2010 at 2:13 pm
Only points I would add to Robespierre’s anaylsis are:
–”Mortgage borrowers misunderstood or ignored the risks of the affordability products.” Borrowers weren’t naive little darlings. While they weren’t the main cause they certainly fueled the fire. During the easy-credit-mortgage days than ran up to the debacle, I worked as an investment consultant in a retail bank — one that never originated crap. I watched the retail bankers get chewed out — daily — because the bank wouldn’t loan a guy money to flip a house based on stated income. “The bank down the street will loan it to me without financials!,” they all yelled. Twist of fate: the bank down the street is the one that had to be saved by the non-crap institution.
–”Investors in both the senior tranches (including the GSEs) and the junior tranches exercised poor judgment in trusting that others on the assembly line….” Exercised poor judgement? I’d say that’s letting them off lightly. They were greedily in search of yield — no matter what the risks.
The optimist in me would love to think that our government is looking into the causes and will take action so it doesn’t happen again. The realist in me tells me I’ve got to be kidding myself…
September 30th, 2010 at 12:16 am
While trying to understand what went wrong and correcting that is a worthy task and one that could fix the problem for the future let me throw in two points:
1. Now that we have shattered the world’s trust, like a cheating spouse found out, how can we ever regain that trust and induce them to buy MBOs – without the full faith and credit of US of A?
2. How will we deal with the uproar when those private investors want 8% or 9% return for 30 years given the risk involved of inflation, of fraud and of default and falling collateral value?
Now that we have betrayed that trust we are in for a long long healing process, if at all. We shat in our own punchbowl. That we are not pursuing those who perpetrated the fraud with full vengence only confirms to outsiders that we are generally understanding of what occurred. Another mistake.
September 30th, 2010 at 10:37 am
dear barry
your friends comment with my edits in caps
“Fannie Mae and Freddie Mac provide, both through their MBS guarantees and through their own balance sheets, has been an important component of this system, and not just for the conforming borrower. Indeed, a conforming borrower has generally paid a lower rate than a jumbo prime borrower,WITH FF EATING THE HUNDREDS BILLION LOSSES TO LATER BE PUT TO THE TAXPAYER
but the conforming mortgage rate also serves as an effective benchmark for other mortgage rates, WHICH MAKES THEM UNDERPRICE, AND LIKELY TAKE LOSSES THEMSELVES LIKE LAST TIME.
i translate “not unbiased” as industry stooge.
So enjoy your lunches, friendship and whatever else.. why does “not unbiased” appear here?
or have your friend explain to me why a dollar spent to further subsidize a glutted overstuffed housing mkt and him personally better than a dollar spent elsewhere?