What would happen to the government-controlled enterprises Freddie Mac and Fannie Mae if consumer sentiment and the U.S. real estate market took a sharp turn for the better?
So far, losses at the pair of secondary mortgage lenders have cost the Department of the Treasury $156 billion, and the government has said it will continue to do whatever it takes to keep the two companies solvent. Fannie has requested $91.2 billion in capital injections to date from the Treasury, while Freddie has requested $64.7 billion.
But what would happen if consumer sentiment improved, and the supply of home buyers grew?
Some positive signs have been emerging.
Karl Case, a professor at Wellesley College, recently argued that a quick turnaround in the real estate market could occur, depending on how confident consumers were about a recovery.
“It is possible the mood could change, and the mood could change very quickly,” Case reportedly said.
Positive signs in the residential property market have been mounting, with improvements noted in delinquency trends and foreclosure activity.
Conforming mortgages higher than 80 percent loan to value require mortgage insurance. Primary insurance defaults at members of the Mortgage Insurance Companies of America have declined to 64,687 as of January from 89,850 in January 2010.
Delinquency of at least 90 day at Freddie, which also provides an early look at defaults, was 3.82 percent in January, improving from 4.15 percent a year earlier.
And last month, 225,101 U.S. properties faced some sort of a foreclosure notice, the lowest level of activity in the past 36 months, according to data from RealtyTrac. Completed foreclosures amounted to 64,643, lower than 78,683 in February 2010.
Freddie’s own chief economist, Frank Nothaft, says a positive shift in consumer sentiment would be met with other good news.
“Improving consumer sentiment toward the housing sector would likely coincide with better macroeconomic news as well,” Nothaft explained in a written statement to Mortgage Daily. “This suggests strengthening of job and income gains and a pick-up in non-housing wealth for families (for example, increase in stock market values and investment portfolios), which helps to improve family balance sheets and support housing demand.”
Nothaft noted that any improvement in consumer sentiment will only accelerate improvement in delinquency.
At the Mortgage Bankers Association, the group’s vice president of research and economics, Mike Fratantoni, concurred with Nothaft about the benefits of a change in consumer sentiment.
“When the housing market improves, whether through a change in homebuyer sentiment and/or improvement in underlying economic conditions, delinquency and foreclosure rates will drop,” Fratantoni told Mortgage Daily in a written statement. “In fact, we are beginning to see signs of this already, as evidenced by the sharp declines in delinquencies in the Q4 2010 data.”
Fannie earned a $73 million fourth-quarter 2010 profit versus, better than its $15 million loss a year earlier. And Freddie had a $113 million loss in the fourth quarter, a huge improvement over the $6.5 billion loss during the fourth-quarter 2009.
But plenty of caveats lurk beneath the surface.
One is the shadow foreclosure inventory that has become more bloated as servicers wrestle with affidavit issues. Stubbornly high unemployment also presents an ongoing challenge to any bounce back in the housing market.
Another weak sign was that pending home sales fell for the second consecutive month in January and were down 1.5 percent from a year earlier, according to the National Association of Realtors.
MBA’s Fratantoni said the trade group expects steady, but modest job growth and lower delinquency over the next couple of years but doesn’t see the return to normal levels of delinquency and foreclosures for years.
And, as noted in a recent report from Moody’s Analytics Chief Economist Mark Zandi and Moody’s Analytics Director Cris DeRitis, nobody is comfortable with the government’s current role in the mortgage market and such involvement is not sustainable over the long term.
“Acting on behalf of taxpayers, the FHA is taking on much more credit risk than was ever envisaged for this institution, and Fannie and Freddie are operating in conservatorship, a kind of regulatory purgatory,” the report stated.
While the Obama administration issued a plan last month to wind down Fannie and Freddie, the statement seemed to leave a little wiggle room for a possible trimmed-down entity.
“We recognize the critically important role that Fannie Mae and Freddie Mac and their employees have played in the housing finance market while they have operated in conservatorship,” the statement from the Treasury said. “We look forward to continuing to work with them to find ways to develop and implement the longer term reform solutions that the administration determines together with Congress.”
But Ed Pinto, former chief credit officer at Fannie and a frequent witness on Capitol Hill at Congressional hearings about the two housing finance giants, says that that the administration was very clear in its plan.
“Winding down is still not a done deal; it ain’t over until it’s over,” Pinto said in a telephone interview about the administration’s statement. But “I thought it was pretty firm about winding them down.”
Despite slightly improving finances at Fannie and Freddie, Pinto says declining house prices will continue to wear on the bottom line for at least the next quarter or two.
Pinto added that the two companies don’t have any capital, and they are still government-sponsored enterprises — two issues that wouldn’t be solved by an improving real estate market.
“If you leave Fannie and Freddie, or any successor entity or entities that smell and look like Fannie or Freddie, then the market will once again assume they’re too big to fail and are backed by the government — and you are right back in the implicit guarantee,” Pinto said. “Doesn’t make any difference if the government protests that it’s not there; they did that for 20 years … you really can’t leave them in place and you can’t resurrect them or you can’t rehabilitate them.”
