The Feds Are Running The Show

We are finishing up a trying year in the mortgage
business. After last year's near-death experience
with economic calamity, the federal government
has been doing everything it can to prevent any
chance of a recurrence of the events that led to
the "mortgage meltdown".

Because the government is so involved in the
process, it is important to understand that the
lenders are being handcuffed from making many
of their own decisions about lending programs
and approval criteria.

Let's take a look at what type of lending is
prominent in today's market:

Conforming loans: These are the loans that
are designed for sale to FNMA (Fannie Mae)
and FHLMC (Freddie Mac), and currently have
a maximum loan limit of $417,000. FNMA
and FHLMC are "government sponsored
entities (GSE's)", and the performance of these
corporations are backed by the Federal Govern-
ment.

FNMA and FHLMC have written guidelines
that define what loans they will purchase from
the lenders after the loans are funded and closed.
Traditionally, there is room for interpretation
with these guidelines, and underwriters have
latitude to make loans outside of these guidelines
if there are sufficient "compensating factors" -
reasons why making an exception does not
present a risk. A couple of the most common
compensating factors are a low loan amount in
relation to the value and strong liquid assets
after closing.

High-balance conforming loans: These loans
have come into play when the mortgage melt-
down hit the market hard, and institutional
investors (non-government) refused to buy
loans because the quality had been poorly
represented and they suffered losses.

These high-balance conforming loans are also
eligible for sale to FNMA and FHLMC and
have maximum loan amounts based on the
county in which the property is located. They
are to be underwritten with many of the same
guidelines, although there are more restrictions
in this category, because FNMA and FHLMC
don't want to take higher risks with higher loan
amounts.

FHA Loans: The last bastion to enable the
general public to buy a home with a small down
payment is the FHA program. It allows buyers
to put as little as 3.5% as a down payment, and
liberally allows for gift funds for the down payment
and closing costs, and for family members to
co-mortgage to help in the qualifying process.

There are minimum property requirements that
need to be met, and condominiums require some
additional scrutiny that may make many projects
ineligible, but it fills a need for first-time buyers
that the conventional market is avoiding right now.

It is also a government-backed program. In the
past, conventional loans were available up to 95%
of the value of the home, but these were made with
the support of private mortgage insurance (PMI).
PMI has backed off from insuring loans to those
maximums, again due to the losses that these
companies incurred when the mortgage meltdown
occurred.

VA loans: Another government-backed program,
available to active-duty military and honorably-
discharged veterans. These loans allow for an
eligible borrower to finance up to 100% of the value
of the home.

Guidelines are reasonable, and tend to give the
benefit of any doubt to the veteran, within reason.
They want to help their military members obtain
homes, without making excessively risky loans.

So, the majority of the mortgage market is being
driven by the directives of the federal government
and the financial support of the U. S. taxpayer.

There are lenders that do create loans for their
own lending portfolio, and do not rely on making
the loans for sale to the GSEs. Many of these
lending programs are adjustable-rate loans, because
the lender does not want a fixed rate of return on
their money, when the cost of money is subject to
change.

These portfolio lenders, as they are called, have
put together business plans that have worked
very well for themselves. But, even though they
have a proven track record of their business plan
being successful, there is still pressure from the
government to conform to what the government
wants them to do.

For example, stated-income loans were prominent
when the go-go days in the mortgage business
were happening. These loans did not require proof
of income, and many lenders, investors, and rating
agencies were not especially diligent in controlling
the risks associated with these loans.

Stated-income loans were summarily regarded at
that point as being high-risk and to be avoided at
all times. However, there were still lenders that
had done a good job of controlling the risks by
requiring higher credit scores and strong cash
reserves that had a correlation between the
balances on hand, and the income that was being
represented on the loan application.

These lenders could show statistically that they
had good performance with their business model.
But, despite this fact, bank regulators "strongly
encouraged" them to drop this lending program.
If the bank insisted that they wanted to continue
to serve the market with this lending vehicle, the
regulators informed them that they would continue
to review the bank operations for compliance in
all areas.

Nobody wants the federal regulators to hang
around their business any longer than necessary,
and the bank got the message that they needed to
drop a program that the government deemed to be
high-risk.

You continue to hear a lot in the media from the
politicians that they are doing everything to get
money "from Wall Street to Main Street", and that
they don't understand why the money is not being
lent to borrowers.

It is disingenuous on their part to ignore the role
of their own federal regulators who are looking over
the shoulder of the lenders and making sure that they
don't make any mistakes. When the politicians are
saying that the banks have a green light, and the
regulators are waving the stop sign, the banks pay
attention to the stop sign.

Making loans to good borrowers is easy. Rejecting
loan request to clearly bad borrowers is easy. But
there is a huge number of borrowers in the middle
of that spectrum, and underwriters are gun-shy about
making any decisions for which they may be criticized.

When that happens, they tend to adhere strictly to the
underwriting guidelines and not make any exceptions,
no matter how reasonable the request may be. It is
the safe thing to do, but it does not allow for a big group
in the borrowing population to be served.

Let us hope that as we head into 2010, that there can
be a rejuvenation of institutional investors who are
willing to encourage creativity and reasonable risk in
the creation of mortgage loans. Only the private
market can be counted on to do so. And, the reward
for all of us will be that the taxpayers can be taken
off the hook for the risk associated with almost all the
mortgage loans being created, and that can be shifted
to investors.