On Wednesday, January 8, 2008,
Daniel Mudd, President and CEO of Fannie Mae, spoke to th U.S. Chamber of Commerce with his predictions on the state America's business 2008. Asummary of his remarks might be the following statement "The state of American business in 2008 and beyond will depend on the choices we make about housing today."
He outlined five short term actions: "First, the
Treasury Hope Now initiative is an important step. By helping a set of subprime borrowers to freeze their payments at the initial ARM rates, we can avoid creating a whole new class of distressed borrowers.
Second,
lenders and policymakers should pursue the most generous means possible to refinance ARM borrowers facing resets into long term, fixed-rate mortgages. This will require innovative high quality products that replace the sloppy credit that has been – appropriately – withdrawn from the market. There is now, for example, a 40-year mortgage designed to keep payments lower but level for the life of the loan. Washington Post columnist Steve Pearlstein has suggested a kind of “equity participation mortgage” for subprime refinancings in which both the lender and the borrower share any eventual recovery of the equity lost in the refinance.
Third,
public outreach is critical. It’s a senseless tragedy when people lose their homes just because they didn’t know what to do – and were afraid to ask.
Fourth,
banking regulators could give their institutions favorable CRA consideration for what you could call “MRA” – or Mortgage Reinvestment Act – loans. Banks would receive extra CRA credit for providing secure financing to borrowers who are facing exploding subprime loans and in communities suffering foreclosures.
Fifth,
in those cases where foreclosure appears inevitable, and the family cannot stay in the home, alternatives exist to leave the home in good condition and enable a quick exit with minimal financial damage to the family AND the lender.
Here’s a
not-to-do:
Policies should not damage the credit markets by cramming down losses or abrogating the rights of lien or securities holders. Altering basic contracts would have a high price. Investors left with the losses would not easily return to the market. That inevitably would shrink the pool of credit. The Chamber has sounded the warning against regulating risk out of a system that relies on risk and reward as its foundation."
He then went on to suggest 5 long term reformsplans "Long-term, I believe the focus should be two-fold. First, we need to make balanced reforms to the lending system. Second, we need to restore the fundamental healthy demand for housing, based on people who want and can afford to buy a home. I’ll offer some examples"............."There are
five key areas that are ripe for reform:First,
mortgage brokers should be licensed. A House-passed bill, supported by the brokers themselves, would create a national registry of loan originators regardless of where they work in the industry. It also establishes strict national standards for loan originators that include criminal background checks, fingerprinting, continuing education and testing.
Second,
predatory lending laws should be strengthened: Clearly we need to tighten the definition and toughen the penalties for ripping people off. Here, the efforts by Congressman Frank and Senator Dodd have been a good start. The challenge, however, is to get the definitions and penalties right so that we stop bad lending without discouraging the good lending. Where borrowers were defrauded, the fraud should be vigorously prosecuted.
Third,
we should improve mortgage disclosure. Much of the present hangover came from consumers taking on loan products they didn’t understand, payments they couldn’t afford, and/or calculations for pricing and fees that belong in a supercomputer, not a mortgage. As we’re seeing now, when enough consumers get hurt, the industry gets hurt too. So the industry’s long-term financial incentive is to provide more simplicity, transparency and consistency. One cover page – your starting rate, your maximum rate, your starting payment and your maximum payment – that’s it. The Fed’s effort to simplify mortgage disclosures is welcome. So is the Mortgage Bankers’.
The challenge, here, though, is to avoid the perfect from becoming the enemy of the good.
Fourth,
we should improve homebuyer education: The mortgage industry should make a commitment to arm consumers with financial literacy and homebuyer education so they avoid making the wrong mortgage choices in the first place.
Fifth,
we need a private-label market review. While the so-called private market has nearly collapsed from the subprime meltdown, it will rise again. So it’s worth taking a hard look at what happened to allow so much unsustainable lending there. The rating agencies, Wall Street, structured investment vehicles, the creation of instruments to disperse risk that actually magnified risk – these are all due scrutiny and introspection, if not regulation."
Mudd then went on to outline four lessons that are to be learned from recent events. Perhaps my
favorite is the first "Lesson one: When they say the old rules don’t apply, apply the old rules. No market is exempted from the laws of gravity, and that includes housing and home loans. Home prices were not going to keep rising without interruption; supply and demand eventually have their due.
The full text of Danial Mudd's speach to the Chamber of Commer follow:
"Good afternoon, and happy new year – I hope. The state of American business this year will depend, I believe, on how we get through the toughest housing correction in our lifetimes.
It is clear that housing is critical to the US economy. The building, selling, buying, lending, fixing and furnishing of homes generates 9 million jobs, six percent of all employment, and more than 20 percent of our gross domestic product. Typically we spend 20 to 30 percent of our income on housing and our homes represent 18 percent of our net worth.
It is also clear that the housing correction has been damaging to the economy. It’s taken $166 billion off the GDP … cut the jobs outlook by nearly half a million … knocked $1.2 trillion off of property values – and raised the specter of broader recession.
For the business community, the quality of life for every one of our workers depends on the houses they go home to, the communities they live in – and how many of their productive hours are disrupted by fear of whether they can make that house payment.
So when we examine the state of American business, and look at the year ahead, the housing correction is the relevant topic. Simply stated, the state of American business for 2008 depends on how quickly housing stops detracting from GDP.
I’d like to touch on how we got here, and then offer some thoughts about what we can do right now – and in the long term – to get through the correction to recovery.
What Happened?
Let me review briefly how we got here.
As the decade started, incomes were rising and interest rates were low and stable. Demand for homes outpaced supply, driving a sustained boom in home prices. Affordability plummeted.
Nevertheless, first-time homebuyers scrambled to get in, spending more and more of their income to purchase homes. The mortgage market, being efficient and responsive, offered new loan products with features that lowered initial monthly payments – teaser-rates, interest-only, negative amortization and the like.
These products shifted more risk to consumers. But demand continued to spiral prices upward. Credit underwriters kept underwriting, and all bets were covered by the upward march of home values. Homeowners took out a steady stream of cash – nearly two trillion dollars since 2003 – by refinancing or borrowing against the value of their rising equity.
The homebuilding market – also being efficient and responsive – built a record 7 million new single-family homes during this period, boosting supply significantly.
Then … cracks started showing in the market. Inventories of unsold homes began to grow. Some of those new mortgage features expired and consumers – particularly at the lower end of the credit spectrum – started to struggle as their monthly payments jumped up.
Last summer, the music stopped. Subprime foreclosures began to mount. Investors pulled back, touching off a liquidity crisis among subprime lenders, and six out of the top ten folded or were sold. Many large-scale lenders carried significant exposure to subprime loans – and they responded by tightening up. That triggered a broader credit crunch.
The markets began to exude the scent of panic in August and again in October, and distressed mortgages began to crop up in places we hadn’t seen before – Wall Street, big banks, hedge funds, overseas investors. You began to hear about holders of esoteric securities like CDO’s, SIV’s, and beyond. Essentially by Thanksgiving, confidence had evaporated.
Today, my expectation is that home prices – on average, nationally – are likely to decline by 10 to 12 percent, peak to trough, through 2010. Specifically, home prices are likely to remain weak into '09, and then perhaps begin to gain modestly in 2010. That depends on inventories and consumer confidence. But the housing market as a whole (credit, construction, foreclosures and so forth) should begin stabilizing – stabilizing, not booming, or even recovered – in the second half of this year, and the correction could morph into recovery by 2010.
However, the duration of housing’s drag on GDP can be shortened or lengthened, depending on whether the industry, policymakers and regulators come together to make the right choices.
Having studied past dislocations in Texas, California, Asia, in the 1970s, it is clear that there is no single magic bullet. Multiple parties will have to take multiple steps over time to restore confidence. The most effective steps, historically, are solutions that buy time to restore normal housing supply and demand … solutions that have broad political support … and solutions that take a hard, realistic stance to “getting it over with” – rather than just nickel-and-diming the problem.
With that in mind, there are two broad policy areas to focus on here, and I think it is extremely important to keep them un-muddled.
First, there are immediate actions to make housing’s drag on the economy short and shallow. Second, there are longer-term reforms that take the lessons of this crisis to heart and buttress the future strength of the housing industry.
What we do right now
Let me sketch some immediate actions that I believe would make the slowdown shorter and shallower.
According to the Mortgage Bankers Association’s third quarter 2007 National Delinquency Survey, over 90 percent of mortgage borrowers were current – they generally have good loans on good property. But for those in trouble, the first goal is to avoid foreclosure – a lose-lose proposition for homeowners, lenders and communities. Door-to-door, it costs roughly $20,000 to $50,000 to foreclose – and with the average home of $140,000, you can see what I mean.
Here are five short-term remedies:
First, the Treasury Hope Now initiative is an important step. By helping a set of subprime borrowers to freeze their payments at the initial ARM rates, we can avoid creating a whole new class of distressed borrowers.
Second, lenders and policymakers should pursue the most generous means possible to refinance ARM borrowers facing resets into long term, fixed-rate mortgages. This will require innovative high quality products that replace the sloppy credit that has been – appropriately – withdrawn from the market. There is now, for example, a 40-year mortgage designed to keep payments lower but level for the life of the loan. Washington Post columnist Steve Pearlstein has suggested a kind of “equity participation mortgage” for subprime refinancings in which both the lender and the borrower share any eventual recovery of the equity lost in the refinance.
Third, public outreach is critical. It’s a senseless tragedy when people lose their homes just because they didn’t know what to do – and were afraid to ask.
Fourth, banking regulators could give their institutions favorable CRA consideration for what you could call “MRA” – or Mortgage Reinvestment Act – loans. Banks would receive extra CRA credit for providing secure financing to borrowers who are facing exploding subprime loans and in communities suffering foreclosures.
Fifth, in those cases where foreclosure appears inevitable, and the family cannot stay in the home, alternatives exist to leave the home in good condition and enable a quick exit with minimal financial damage to the family AND the lender.
Here’s a not-to-do: Policies should not damage the credit markets by cramming down losses or abrogating the rights of lien or securities holders. Altering basic contracts would have a high price. Investors left with the losses would not easily return to the market. That inevitably would shrink the pool of credit. The Chamber has sounded the warning against regulating risk out of a system that relies on risk and reward as its foundation.
So … in the near term, keep the foreclosure wave from becoming a malignancy on communities and our economy. That means buying time for borrowers and lenders to work through the cycle, making safer fixed-rate refinancing available to those who qualify, and delivering services and counseling to every at-risk borrower out there. Will these efforts require some stretching by our industry? Yes. Will they be costly in the short term? Yes. Will they help restore confidence to the housing market? If we act fast, yes.
What we do long term
Long-term, I believe the focus should be two-fold. First, we need to make balanced reforms to the lending system. Second, we need to restore the fundamental healthy demand for housing, based on people who want and can afford to buy a home. I’ll offer some examples.
Reforms to the lending system need to moderate excess, again, without creating disincentives for rational, responsible risk taking … what we call “lending.” We have a credit crunch now, but we don’t want to amplify cycles in the future.
There are five key areas that are ripe for reform:
First, mortgage brokers should be licensed. A House-passed bill, supported by the brokers themselves, would create a national registry of loan originators regardless of where they work in the industry. It also establishes strict national standards for loan originators that include criminal background checks, fingerprinting, continuing education and testing.
Second, predatory lending laws should be strengthened: Clearly we need to tighten the definition and toughen the penalties for ripping people off. Here, the efforts by Congressman Frank and Senator Dodd have been a good start. The challenge, however, is to get the definitions and penalties right so that we stop bad lending without discouraging the good lending. Where borrowers were defrauded, the fraud should be vigorously prosecuted.
Third, we should improve mortgage disclosure. Much of the present hangover came from consumers taking on loan products they didn’t understand, payments they couldn’t afford, and/or calculations for pricing and fees that belong in a supercomputer, not a mortgage. As we’re seeing now, when enough consumers get hurt, the industry gets hurt too. So the industry’s long-term financial incentive is to provide more simplicity, transparency and consistency. One cover page – your starting rate, your maximum rate, your starting payment and your maximum payment – that’s it. The Fed’s effort to simplify mortgage disclosures is welcome. So is the Mortgage Bankers’. The challenge, here, though, is to avoid the perfect from becoming the enemy of the good.
Fourth, we should improve homebuyer education: The mortgage industry should make a commitment to arm consumers with financial literacy and homebuyer education so they avoid making the wrong mortgage choices in the first place.
Fifth, we need a private-label market review. While the so-called private market has nearly collapsed from the subprime meltdown, it will rise again. So it’s worth taking a hard look at what happened to allow so much unsustainable lending there. The rating agencies, Wall Street, structured investment vehicles, the creation of instruments to disperse risk that actually magnified risk – these are all due scrutiny and introspection, if not regulation.
As we make these balanced reforms to the system, we also should look at ways to unleash the latent demand for housing. I can think of three groups of people we should reach:
First, New Americans are the fastest growing segment of the population and housing market. Their path to homeownership remains tortuous. Over the past ten years, the IRS has issued close to 8 million individual tax identification numbers – ITINs – to new Americans. ITIN lending is a tough issue for the mortgage industry because there is no unified regulatory view of whether the ITIN is an appropriate form of legal verification. Maybe it’s time to create a national standard for ITIN use that would allow the mortgage industry to serve these taxpayers. Eight million potential legal homebuyers – even if only five to ten percent ultimately qualify – would produce a big jump in demand, and would illuminate a huge gray area in US lending.
Second, armed forces veterans and military personnel are another underserved population. I think the people who defend America deserve a shot at the American Dream. Right now, VA loans offer favorable rates and terms. We could beef that up by offering lower down payments, help with closing costs, homebuyer savings programs, affordable loans, and homebuyer counseling, offered through military credit unions and banks that serve base communities. I’m suggesting that the mortgage industry team up with the VA like it has with FHA to give all military families the best we have to offer. This is another source of huge demand.
Third, minority families and communities are at greatest risk of foreclosure because they took on a disproportionate share of subprime loans. Whole neighborhoods could be wiped out. The African American homeownership rate, after years of slow gain, is already sliding backwards. Our progress as a nation to achieve housing equality is at risk. We must not let the housing correction take our eyes off closing the gap in minority homeownership. Perhaps the community lending rules for banks could be changed to define underserved areas as not just based on income, but also those with large minority populations.
I put these proposals under the long-term umbrella, but we shouldn’t wait to work on them. None of them – demystifying loan disclosures, educating borrowers, jailing predators, serving communities long ignored or shunned – are new. What IS new is the urgency to act – and the recognition that it’s critical to the industry’s health.
The GSE role
Now, allow me one luxury. I’ve spoken for 20 minutes, and not mentioned four words even once: Fannie, Freddie, Mae or Mac. Obviously, this all matters a lot to my company. We have a lot at stake. Essentially, we are the largest US lender, property holder, housing investor, and the key link between the global capital markets and Main Street. Our job, under charter, is to help provide stability, liquidity, and affordability to the market in good times and in times like these.
Let me tick off where we stand on three or four matters relevant to the problems at hand:
There has been concern about illiquidity in the jumbo market – those loans above $417,000 where Fannie and Freddie do not, by law, participate. In a lot of lower-cost states, this is not an issue. But in high-cost states like California, New York, Massachusetts, Connecticut and Florida, a $400,000 home is near the median. Secretary Paulson, the mortgage bankers and others have called for raising the loan limit. I agree, and Fannie Mae is ready to take action.
Likewise, we endorse legislation, along the lines of the bill passed by the House of Representatives, to modernize the regulatory oversight of the GSEs, which gives our regulator powers no different than those typical to regulators of banks or other financial companies. We’d like to see legislation.
Fannie Mae has a major role to play in minimizing foreclosures. We have an initiative called “HomeStay” that streamlines refinancing of subprime ARMs into prime, fixed-rate loans. We are part of Treasury’s Hope Now initiative. Our foreclosure-prevention operations in Dallas help about half of our seriously delinquent borrowers work out their loans. Last year we helped about 100,000 homeowners stay in their homes. We reimburse lenders for referring troubled consumers to counseling agencies, and we have donated more than $7 million to these agencies to make sure they can respond.
Finally, to ensure that we’re in good shape to weather the correction and help the market through it, we’ve adjusted our pricing, tightened our credit standards and bolstered our capital reserves. These steps are critical to our ability to help stabilize the market in the longer run.
During the housing run-up, we kept our exposure to subprime and exotica limited. But no one is immune to the rise in foreclosures and decline in mortgage values, and we’re taking our lumps. Again, we are not the sole solution to the market’s woes, but we are part of the answer. Ok, enough about us…
Lessons learned
So … looking back, we know what led up to the housing correction – risky lending chasing rising home prices fueling more risky lending … until the bubble burst. Looking at the situation now, there are some short-term remedies to minimize the pain as the correction plays out. Looking ahead, there are some longer-term remedies that would help protect borrowers and sustain a healthy demand for homes.
But stepping back from the particular problems and solutions, what are the greater lessons we can learn from this experience, to ensure – as best we can – it never happens again?
Lessons tend to get better and clearer over time, but already, at least four seem clear.
Lesson one: When they say the old rules don’t apply, apply the old rules. No market is exempted from the laws of gravity, and that includes housing and home loans. Home prices were not going to keep rising without interruption; supply and demand eventually have their due.
Lesson two: Financial shocks often begin with a liquidity correction in one segment – in this case the subprime market – that spreads across the landscape. Modern credit markets are not divided into discrete buckets. When investors flee and the funding stops flowing to one area, it winds up affecting the entire watershed – in this case hurting not just people who made bad choices, but millions more who lose their jobs or can’t buy a home.
Lesson three: The fractured nature of the industry, both in terms of participants and regulators, complicates a coordinated response to a crisis like this. Think about the parties involved when you buy a home – a builder … a Realtor … an inspector … a mortgage originator and/or broker … a title company … lawyers. And you could have gotten your mortgage under the unseen purview of any number of regulators: the Fed … the OCC … the OTS … the SEC … OFHEO … the FDIC … the state insurance commissioner … the state banking commissioner, or others. Accordingly, when problems arise, figuring out what the problem is, what to do about it, and who holds the policy controls takes time. We need a more unified approach to housing finance policies. For another day, maybe a single, national regulatory agency will make sense.
Lesson four: The policy choices are not as stark as “free market” versus “bailout.” No one is in favor of bailouts. Nor does anyone seriously think American markets – particularly the financial markets – should be free from rules, regulations or consequences. The best proposals, in fact, seek to help families who can be helped, strengthen consumer protections and provide a measure of stability to the market, while avoiding broad moral hazard.
Taken together, these four lessons point, I hope, to a new appreciation for the role of housing in the economy, in the financial markets, in our policymaking and in our political process. The correction has given us an opportunity to come together and remind ourselves of what’s really important: And that is the interests of the families who buy or rent the homes we build, sell and finance. What’s good for them is good for housing, a good system … which can be made better.
Going forward
Indeed, as we go forward, there seems to be a lot of room for consensus and common ground for minimizing the impact of the correction on homeowners, communities and the economy.
The notion seems pretty fundamental in this country that a prosperous, sustainable society is built on stable communities where the right to own property gives citizens a stake in the place where they live. And so it is in our shared interest to work to stabilize the communities where that stake is in jeopardy. If families have the means to own a home, it should be possible to help them stay there. If not, we should be able to find rental housing. In most cases, we should focus on affording consumers the time and flexibility to work through this crisis.
Moreover, on the other side of the correction, underneath the turmoil, there are fundamental factors supporting a strong, stable housing market, and we want to get back there as quickly and smoothly as possible, so that housing resumes its role as a stable contributor to the GDP.
Our nation is growing. Immigration, economic expansion and demographics all drive the demand for homeownership. Over the next 10 years, one way or another, the US population is expected to grow by over 26 million people. They will create 15 million new households. They will demand 2 million new homes built every year. I believe as the current cycle works itself out, and the correction turns to recovery, home price growth will reassert itself at sustainable rates.
The question for the state of the economy is simply whether we pull together and deliver a recovery sooner, or we wait and hope until later, at the cost of time, money and human suffering. The state of American business in 2008 and beyond will depend on the choices we make about housing today.
Thank you. "
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