Whims of the Biden Administration wreak havoc on home lenders

By: ameer@trustedteam.com

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If President Joe Biden really wants to win reelection in 2024, he should leave the mortgage industry in peace and find somebody else to torment. 

Progressives of course love to raise taxes, but not all taxes are overt and explicit. When government agencies change the rules of the game in mortgage lending in midstream, the various officials in state and local governments are effectively taxing private capital.  

Consider how officials at the Federal Housing Finance Agency are changing the rules on COVID loans after asking the mortgage industry to spend its own time and money to help victims of the pandemic. Both Fannie Mae and Freddie Mac are apparently taking the position that loans that were delinquent for even a month during COVID will not be treated the same as loans that are delinquent during a natural disaster. 

The message from President Joe Biden and FHFA Director Sandra Thompson to the mortgage industry: “COVID was not a natural disaster.”

Freddie Mac, for example, is stating that COVID does not meet its definition of a disaster and so forbearance offers made to customers for COVID will NOT be considered as having made on-time payments. Despite the fact that the Biden White House and both Fannie and Freddie required servicers to offer the forbearance plans, they are now changing the rules after-the-fact to protect the GSEs.

When one large conventional issuer confronted Freddie Mac over this policy change, it was said that officials were embarrassed to admit that they weren’t following the same protocol for COVID as in other natural disasters. If this is in fact the stance taken by Director Thompson and the GSEs, the next time servicers are requested to offer up solutions for events similar to the COVID pandemic, they are going to say no.

The effect of this definitional game being played by the GSEs is that the reps and warranties liability for loans that were delinquent during COVID will never sunset. The number of loans involved is thankfully small, but this arbitrary decision by the GSEs means that issuers will face open ended contingent liability for these loans.  It also demonstrates, yet again, that the GSEs cannot be trusted as business partners. 

Even as the FHFA changes the rules for COVID loans, Director Thompson is likely preparing to provide sweeping, open-ended forbearance to insolvent banks and thrifts which no longer qualify for FHLB membership. FHFA frets about the capital position of independent mortgage banks (IMBs) with no retained portfolios of loans or MBS, yet the agency will turn a blind eye to the growing problem of insolvency among banks because of the rapid increase in interest rates.

The third and largest GSE, namely the Federal Home Loan Banks, have issued a notice to members that the huge negative valuations on securities and loans caused by the 400bp increase in short-term interest rates have rendered many FHLB members insolvent and thus unable to participate in advances. For the same reason, ironically enough the FHLB’s themselves have suffered significant capital impairment.

“Currently, the FHFA’s definition of tangible capital does not align with the definitions used by our members’ prudential regulators,” notes the FHLB of New York in a missive to members. “[G]iven the Federal Housing Finance Agency’s (FHFA) regulations at 12 CFR 1266.4 pertaining to negative tangible capital, it is possible under certain conditions that the Federal Home Loan Banks may not be able to consider otherwise healthy financial institutions to be in good standing with their cooperative.”

At the end of Q3 2022, the U.S. banking industry had a $347 billion deficit in terms of the current market value of available for sale (AFS) securities and loans. But these banks are not “otherwise healthy institutions” contrary to the statement from the New York FHLB. If we mark-to-market the AFS and retained portfolios of many FHLB members, they would be profoundly insolvent and may eventually be closed by the FDIC. 

Likewise, the FHLB’s themselves will likely reveal a profound capital deficit when they report their 2022 financial statements to Congress later this year. Also, both Fannie Mae and Freddie Mac have significant unrealized losses in their portfolios that are already disclosed.  

If the FOMC keeps interest rates at or above currently levels for all of 2023, for example, many banks and GSEs with large negative balances for accumulated other comprehensive income (AOCI) may be forced to sell loans and securities from 2020-2021 at a significant loss, 15-20 points below original cost. FHLB regulations do allow member banks with negative tangible capital to renew outstanding advances, one FHLB member notes.

Perhaps before this looming disaster occurs, and banks and the GSEs too are forced to fire sale low-coupon assets at a loss, the FHFA will re-open the structured desks of both GSEs to allow banks and REITs to repackage seasoned underwater loans and MBS. And again, the FHLBs and the Federal Reserve Board have similar problems with low-coupon loans securities that are now trading in the 70s and 80s vs over par a year ago. 

While the FHFA and other regulators berate the IMBs for being undercapitalized and therefore a source of risk to the GSEs and the entire mortgage finance complex market, in fact it is the depositories with large retained portfolios of underwater loans that pose an imminent and growing threat to the conventional and government mortgage markets. All three GSEs are hobbled by similar problems.

In coming weeks, look for the FHFA to join with prudential regulators to officially ignore the growing insolvency of banks and REITs. The crisis among insolvent banks in the US is worse than with the S&Ls in the 1980s, but you won’t hear Director Thompson, Federal Reserve Board Chairman Jerome Powell or President Biden say a word about this in public.  

In the strange world of Washington, the IMBs that make the world of mortgage finance possible are treated as second class citizens and federally insured depositories are, well, GSEs that are afforded massive subsidies and forbearance.  

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