Jan 24, 2020
Let's talk about a topic I know you're all eager to discuss: GSE reform. Exciting stuff, right?!
First, what the heck is a GSE and what does it have to do with your mortgage? Glad you asked. Here's the gist of it.
What is a GSE?
GSE stands for Government Sponsored Enterprise and (in the mortgage world) is usually used to refer to Fannie Mae (FNMA) and Freddie Mac (FHLMC). There are actually seven GSEs, including FNMA and FHLMC, who assist borrowers in obtaining housing and agricultural loans and provide liquidity to credit markets on a national basis.
FNMA and FHLMC buy mortgages that banks and lenders originate. Then banks and lenders use the money they make from the sale of those mortgages to make additional mortgages to new borrowers. Fannie & Freddie take the majority of the mortgages they buy, bundle them into mortgage backed securities, and sell them to investors.
A Brief History
Historically, GSEs were designed to be quasi-governmental entities that occupy the space between government agency and private industry. They're established by congress. But they're not agencies of the US government.
An agency of the federal government (like the National Park Service or the Federal Housing Administration) has a department head that is appointed (sometimes requiring congressional approval), is subject to civil service and federal hiring laws, has employees that are employees of the US government, and has a budget that is allocated in the federal budget.
The GSEs, on the other hand, are (supposed to be) privately owned organizations. Congress assigns them limited prerogatives. A GSE can't decide to change its own charter or conduct activities in conflict with that charter. Freddie Mac couldn't decide, for example, to start financing boats instead of homes. GSEs are (supposed to be) supervised by the federal government but not directly managed by it.
In 2008, amid the mortgage meltdown, the government took over two GSEs, FNMA and FHLMC. The government provided them with a combined $191 billion dollars in financial support so they could survive. New management was put in place. And Fannie and Freddie went about rebuilding business and sending their profits to the Department of the Treasury to pay back the bailouts.
What happens now?
While everyone (basically) agrees that removing the GSEs from under the thumb of the US government is the order of the day, they don't necessarily agree on how to get there. It will likely be years before the GSEs are removed from conservatorship. And frankly, everything hinges on the Presidential election next year. It's unlikely the current administration will want to upset the apple cart between now and then. And if a new administration is elected next fall, it's possible the GSEs would not be at the top of the list of priorities.
However the mess is untangled, these are the implications I think we can expect in the next five'ish years:
Remember way back in 2014 when "ability to repay" standards became effective? These regulations require that mortgage lenders verify a borrower's ability to repay their loan. One way of confirming that ability is to originate something called a "qualified mortgage." A qualified mortgage has certain features that make it more likely a borrower will be able to afford their loan payments. If lenders issue qualified mortgages, they are also offered certain legal protections.
One of the features of a qualified mortgage is that the consumer's debt-to-income ratio (DTI) can't exceed 43%. But there is a loophole in the law. A lender can originate a QM loan with a DTI above 43%, as long as that loan is acceptable to Fannie Mae or Freddie Mac. That loophole (known as the GSE patch) is a temporary measure that is set to expire on January 10, 2021 or on the day the GSEs are removed from conservatorship, whichever occurs first.
The expiration date is not expected to be extended. Thus, a year from now, it's possible that we won't be able to originate QM loans with DTIs above 43%. That's a lot of loans.
Note added 03/28/2021: The 43% DTI requirement was eliminated from the QM rule.
A little over 30% of all the loans that we close in my office have DTIs above 43%. 19% have DTIs above 45%. And 4% have DTIs above 50%. Now, some of those we would close anyway. We'd get the consumer into a non-QM program, use additional income (we don't always use all income in qualifying if it's not needed), put the boyfriend on the loan, or find a co-borrower. But that's still a substantial number of people who would not be buying a home.
Fannie and Freddie could return to their roots. The GSEs were originally established to promote homeownership. But now they securitize loans for investment properties, vacation homes, loans in excess of $500,000 (or more in higher cost areas), and "cash out" refinances for homeowners looking to access their home's equity. I think it's likely that we'll see Fannie and Freddie's guidelines shrink to eliminate some of these products.
But it's a slippery slope. Nobody wants to leave these folks with no access to credit. The key is that when the GSEs stop buying as many mortgages, new (private) guarantors will (hopefully) step into the breach. I was at an industry conference last October and one of the vendors was a lender who only finances investment properties. Lenders offering non-QM loans also appear to be a growing segment of the market. So to some extent, private industry is already stepping up to the plate.
We're also seeing greater delineation between FHA and conventional mortgages. Fannie and Freddie really stepped on FHA's toes when they re-branded their 3% down loans (FHA requires 3.5% down) and added attractive features to keep the interest rates and mortgage insurance premiums low. They also required conventional credit standards. FHA's credit standards are much more lenient.
As a result, Fannie and Freddie were able to "skim the cream" off the top. Of all the borrowers getting 3-3.5% down mortgages, FNMA and FHLMC got the better qualified borrowers. That's not a great idea as it threatens FHA's insurance portfolio. Indeed, we've already seen FNMA and FHLMC tighten the reins on these programs. They are far less attractive than they were just a few months ago.
I believe that we will see some big changes in the mortgage industry. Five years from now, we could be originating completely different loans than we are today. Today, the majority of loans that we originate in my office are conventional or government, QM loans. I think we'll be originating more non-QM loans in the future, securitized by or sold to private lenders.