By Marylyn B. Schwartz
RISMEDIA, July 23, 2008-Robert Pardes’ (Robert@pardesconsultants.com) resume reads like an entire Who’s Who for one. He is a certified public accountant, attorney, banking management, real estate finance and related capital markets expert. His company, Recourse Recovery Management Services, provides strategic and tactical services relating to impaired mortgage backed securities investments.Interviewing Robert was both fascinating and challenging. Fascinating in that he is a wealth of knowledge and wisdom, and challenging in that his expertise is exemplary, far reaching and comprehensive; capturing the crucial elements, in everyday understandable terms, was tough…Here is part one of my recent interview with him about the mortgage crisis going on in this country and the future of the real estate industry.
MBS: Robert, it is an honor to be chatting with you about subjects that have filled thousands of texts and newspapers worldwide. We are attempting to render some hot topics into pure knowledge that may help our readers work more effectively within the real estate and related industries. That begs the questions, what are, and what is going on with Fannie Mae and Freddie Mac?
RP: First, let’s define what they are. Federal Home Mortgage Corporation (Freddie Mac/FM) was created in 1970 by Congress with a mission to provide liquidity, stability and affordability to the nation’s mortgage markets using private, not public, capital. Congress’ creation of Freddie Mac was a sophisticated and creative approach to the longstanding national goal of promoting homeownership, and a recognition that historically the strictly private markets had failed to provide a stable and affordable supply of credit for residential housing.
Federal National Mortgage Association (Fannie Mae/FM) was created in 1938 as part of FDR’s New Deal. The collapse of the national housing market in the wake of the Great Depression discouraged private lenders from investing in home loans. Fannie Mae was established in order to provide local banks with federal money to finance home mortgages in an attempt to raise levels of home ownership and the availability of affordable housing.
They do their jobs by buying loans from banks, thrifts (S&Ls) and mortgage bankers and either holding these loans in their portfolios or securitizing them (protecting the loans with guarantees against defaults) and selling them to investors worldwide. These entities eventually became privatized, yet they remained federally chartered, meaning they were no longer under government regulations.
They are known as government sponsored enterprises (GSEs.) By privatizing these entities two distinct and significant advantages were achieved. First, the agencies gained an implicit unlimited access to low cost government funds. Second, they were allowed to conduct activities with substantially greater leverage and lower capital levels. The government was in essence a ‘sugar daddy’ for funds in perpetuity.
MBS: Having private ownership and at the same time being required to undertake a public mission are competing interests that have proven difficult to manage. How, if at all, does that implicit funds guarantee feed into the present public ‘crisis in confidence’ that now these agencies are on the brink of ruin and/or running amuck by virtue of not abiding by sound banking practices?
RP: “There are headlines everywhere that leave the reader with the perception or reinforce the reality that these entities are undercapitalized to absorb losses relating to loans they own or guarantees they issued to other investors. They own or guarantee 5 trillion of mortgage debt, and that comprises half of the total outstanding mortgage debt nationally. They have combined capital of 55 billion.
When you do the math, on the surface, it looks pretty grim. The fear is that they could ‘eat up’ the capital quickly. If 10% of loans were in default and 1% of defaults equal approximately 25 billion in liability, a mere 3% default rate would more than wipe out cash on hand.
The national default rate of loans (that is past due or in foreclosure) as of 6/1 was 8.8%. However, Fannie Mae’s and Freddie Mac’s holdings in the risky-loan market (the so called sub-prime or non-prime loan) are nominal. Where it gets sticky, however, is that all their existing capital bases and revenues remaining are inadequate to absorb losses associated with the rapidly declining residential market conditions. In the event that their capital was to continue to show signs of depletion, international or other investors may have significant reservations about borrowing because the cost of borrowing rises when capital depletes.
Liquidity and demand for FM and FM securities would decline and they would be compromised in their ability to support the housing market’s need for loans. Does the government provide direct investment to the entities (what amounts to a blank-check bailout) or does FM and FM look elsewhere to raise capital?
There is presently a boisterous debate on this issue on Capitol Hill as well as on every talking-head Sunday news show. It is not within our imagination for these entities to fail. However, a bailout is not going to resolve the underlying causes of the problems, and now would be the right time to look at those root causes and make needed and overdue changes even if and when the needed liquidity is provided. The fact is that when the government bailed out Bear Stearns, that act turned that ‘implicit’ guarantee of funds flowing in perpetuity from the government to FM and FM into an ‘explicit’ guarantee. If Bearn Stearns was not going to be allowed to tank, how could anyone expect that FM and FM would?
MBS: Those of us who are the gatekeepers of the real estate profession are watching, with great interest, to see how this unfolds. One has to wonder if we bailout FM and FM without curing the ills that brought about this historic turn of events. What’s next? US car manufacturers come to mind… Turning to a tangential topic, what is the possible impact of banks having to take back previously bundled and sold loans (so called mortgage backed securities) from investors by virtue of those loans having been securitized by fraudulent documentation, and the subsequent investors realizing losses due to many of those loans falling into the failed sub-prime category?
RP: Notwithstanding press concerns regarding capital levels on hand of many banks, the impact on the real estate profession is a non-event. There are still many banks that are willing and ready to provide mortgage loans to qualified borrowers. Rather than to worry about more bank failures, real estate and banking professionals should be focused on creating a menu of products to meet the core housing demand. It is crucial to keep in mind that we have had sub-prime type loans for many years.
However, the balance between prime loans and sub-prime loans was maintained in a responsible way. The number of sub-prime loans granted mirrored the demographic of persons for whom those loans were created: 10-15%. It is only when banks and thrifts began to offer sub-prime loans to a broader demographic and simultaneously lowered the lending criteria for obtaining a loan did the problems begin en masse.
Non-prime lending reached upwards of 40% of all loans. There are no doubt going to be lending institutions who will continue to realize loses as a result of poorly securitized MBSs. 2 trillion total is not an unlikely figure. The impact to the marketplace is likely to be that banks will have to dedicate ‘the gift’ bestowed by the Federal Reserve of lower borrowing costs. The banks will have to make investor loans at reduced profits (lower interest rates) to help pay for the take back of mortgages previously sold to investors. There is little doubt that where there is the possibility for proving any fraudulent lending practices, those possibilities will be fully investigated over time.”
Next week Robert Pardes will discuss in detail his recommendations for improving the housing industry.
Marylyn B. Schwartz, CSP, is an expert in real estate and corporate sales training/management and team development. She is president of Teamweavers and a trainer for Leader’s Choice.
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