MReport March 2019

TheMReport — News and strategies for the evolving mortgage marketplace.

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60 | TH E M R EP O RT SECONDARY MARKET THE LATEST O R I G I NAT I O N S E R V I C I N G DATA G O V E R N M E N T S E C O N DA R Y M A R K E T Reforming the GSEs The Milken Institute's housing experts discussed the removal of Fannie and Freddie from conservatorship. H ow can the housing finance system be reformed in the absence of legislation? A new report by The Milken Institute sets out to answer this ques- tion, by building upon the progress that has been made towards a safer housing finance system through the conservatorship of the government-sponsored enterprises (GSEs) under the Federal Housing Finance Agency (FHFA). Titled, "A Blueprint for Administrative Reform of the Housing Finance System," the report makes a case for why the government must avoid releasing the Fannie Mae and Freddie Mac from conservatorship without fixing some of the flaws in their charter. The report's authors, Eric Kaplan, Michael Stegman, Phillip Swagel, and Theodore Tozer out- line actions that can address some of the challenges related to legislative action to set the stage for further reform that "includes changes to the GSE charters." "Ending the conservatorship without further reforms would preserve flaws that allow the GSEs to privatize prof- its and socialize losses," said co-author Eric Kaplan, Director of Housing Finance Policy at the Milken Institute Center for Financial Markets. "Implementing our recommendations would help strengthen the housing finance system and pave the way for bipartisan legislation putting in place the last piece of the housing finance reform puzzle." The report argues that the GSEs' post-crisis success has occurred under the protected "duopolistic status that im- pedes entry and competition, unparalleled access to capital with government backing," and due to the strong economic environment that reflects historically low delinquencies. Some of the actions recommended by the report include greater transparency into and FHFA oversight of GSE activities, more risk-based pricing combined with explicit affordable housing subsidies, and finalizing a GSE capital rule that supports a housing finance system that is "driven by private capital that can survive future downturns and maintain liquidity for creditworthy borrowers throughout the economic cycle." The report also made recommendations for the Consumer Financial Protection Bureau (CFPB). They include actions for CFPB on the ability to repay/qualified mortgage rule and facilitating innovation while maintaining consumer protection. Falling Home Prices and the Secondary Market Home shoppers aren't the only ones who feel the impact of changing home prices. A ccording to recent research, residential mortgage-backed secu- rities (RMBS) investors should be watching home prices just as expectantly as residential home shoppers. However, while home shoppers might delight in falling home prices, RMBS investors should not. Falling home prices are a "dominant influence" on mort- gage default rates, according to research from Collateral Analytics, a provider of real estate analytics and tools. "The impact of price declines on default rates is very strong and consistent across a variety of different locations and corresponding home price levels," accord- ing to a research paper published this week by Collateral Analytics. Of course, price de- clines are not the only cause of default. Job loss, medical expenses, and business losses are also potential threats, according to Collateral Analytics. However, "a total loss of equity is a critical component of any default model," according to the research. When examining data from various metro areas from 2005 through 2018, the researchers found the strongest correlation between home price declines and mortgage defaults in Boston and the least correlation in Washington, D.C. Seattle and Los Angeles demon- strated somewhat typical correla- tions between home price declines and mortgage default rates. When home price declines accelerated by more than 10 percentage points, mortgage default rates increased an additional 7.2 percent in Seattle. In Los Angeles, defaults rose by an additional 5.0 percent under the same circumstances. Across all of the core based statistical areas observed, Collateral Analytics determined the relation- ship between default rates and peak to trough price declines of -0.74. However, when peak to trough prices declined by more than 20 percent, Collateral Analytics found default rates climbed "sig- nificantly." "It is not clear if homeowners are aware of small price declines, but they seem very aware of large price declines," the research stated. Those who purchase their home at the peak of a price cycle are more likely to default, regard- less of other personal circum- stances, such as employment. This was especially the case for loans with high loan-to-value (LTV) ratios. In fact, Collateral Analytics asserted that its research confirms "why conservative loans will be at 80 percent LTV or below." The impact of price declines on default rates is very strong and consistent across a variety of different locations and corresponding home price levels.

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