After two years in exile Fannie Mae and Freddie Mac are returning to center stage, ready to battle with the nation's lenders. The fight isn't over championship belts or gold medals, instead we'll find out who really owns foreclosure losses worth billions of dollars.
The unfolding war has significant implications for both foreclosure buyers and property owners in general. If mortgage investors start winning court battles, lenders will be forced to dump accounting fictions and show real losses. At that point there's little reason to hold foreclosed properties off the marketplace, hoping for higher prices. Instead, there will be a rush to dump distressed properties and accelerate short sales. While foreclosures now represent a quarter of all real estate sales, the percentage could quickly jump and force down home values, at least in the short run.
The “good” news — a term to be used cautiously — is that once foreclosure inventories fall, markets can then stabilize and in some areas home values might actually begin to rise.
The Secondary Market
Fannie Mae and Freddie Mac are “GSEs” or government-sponsored enterprises. They are special corporate concoctions at the heart of the “secondary” market, an electronic trading post where the GSEs buy loans from local lenders, package the mortgages into securities, and then sell the securities they created to investors. The continued functioning of the secondary market is a big deal because about 75 percent of all single-family mortgage originations are purchased by the GSEs.
A lender anywhere in the country can sell qualified mortgages to Fannie Mae and Freddie Mac. Investors from all over the world can buy and sell mortgage-related securities, an expression which can include pass-through securities and mortgage-backed bonds. The money investors pay for such securities enables the GSEs to buy more local loans and so the cycle continues. Along the way the GSEs “guarantee the timely payment of principal and interest on the mortgage-backed securities they issue” according to Freddie Mac.
The key to the system concerns those “qualified” mortgages. The GSEs are willing to buy conventional, FHA and VA loans because such mortgages have precise requirements and standards. A lender who tries to stick the GSEs with an unqualified mortgage can be tossed out of the program. No less important, a lender who sells a tainted loan can be forced to buy back the offending mortgage at face value.
Loan originators thus have every possible reason to carefully follow underwriting guidelines. A loan which fails because of nonpayment within 120 days — or a loan which fails at any time because of fraud — can generate an ugly and unpleasant buyback demand.
How Many Billions?
By the end of the third quarter the GSEs held massive numbers of foreclosures, properties that could not be unloaded with a short sale or through a foreclosure auction. Freddie Mac held 74,910 REO properties while Fannie Mae had 166,787 homes in its REO inventory.
“Not only do the GSEs have an REO problem, they also have a guarantee problem because they promised to make good on the securities they sold to mortgage investors,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com. “The potential liability of the GSEs is a matter of debate but there's little doubt that the final total will be enormous.”
Indeed, some of the loss estimates are astronomical.
- The Federal Housing Finance Agency (FHFA) says Fannie Mae and Freddie Mac have borrowed $148 billion to date from the Treasury but that additional draws could range “from $221 billion to $363 billion through 2013.”
- Credit Suisse says Fannie Mae and Freddie Mac could face $321 billion in losses if home values decline by 10 percent in a year, are flat the next year and rise 3 percent annually thereafter. Of course, if things don't go so well then the losses could amount to $448 billion.
- Standard & Poor's says “the ultimate taxpayer cost to resolve Fannie Mae and Freddie Mac could reach $280 billion, including the $148 billion already invested — money largely spent to make good on loans gone bad.” Things could get worse, however. S&P says that $280 billion “could swell to $685 billion, by our estimate, with the establishment of a new entity to replace Fannie and Freddie that the government would initially capitalize.”
Who Pays?
If Fannie Mae and Freddie Mac are facing vast losses on the mortgages they bought then do they have any claims against the lenders who sold such loans? Can they force private-sector lenders to buy back failed mortgages?
Fannie Mae and Freddie Mac were taken over by the federal government in the summer of 2008. They are now operated by the Federal Housing Finance Agency (FHFA), a governmental entity that in July issued 64 subpoenas “to determine whether misrepresentations, breaches of warranties or other acts or omissions” were made by lenders who sold loans to Fannie Mae and Freddie Mac.
And just what documents does the government want? It's “seeking the contents of loan files, which include documents used in the underwriting process, such as loan applications and property appraisals.”
The potential for lender buybacks has not gone unnoticed and it involves not just Fannie Mae and Freddie Mac. The biggest case so far concerns the Maine State Retirement System and other mortgage investors who sued the Bank of America — the successor to Countrywide Financial — claiming that loans worth $352 billion should be bought back at face value. The suit has just been dismissed — but “without prejudice,” meaning it can be re-filed. As a result of the dismissal, says Bank of America, its liability has been reduced to not more than $31 billion — a sum greater than the profits of the entire banking system in the second quarter.
Meanwhile, other claims loom. As examples, the Federal Reserve Bank of New York and several large investors want Bank of America to buy back mortgage-related securities worth $47 billion. On the West coast, the Federal Home Loan Bank of Seattle has sued 11 lenders, seeking buybacks worth $4 billion.
In one suit, the bank alleges that a mortgage seller “made numerous statements to the plaintiff about the certificate and the credit quality of the mortgage loans that backed it. Many of those statements were untrue. Moreover, the defendants omitted to state many material facts that were necessary in order to make their statements not misleading.”
How much, if anything, mortgage investors can get back from loan originators and packagers is unknown. A report from Goldman Sachs says the nation's four largest banks will likely need $26 billion to cover “putback” claims during the next few years — that's $15.5 billion for the Bank of America, $5.3 billion for JPMorgan Chase, $2.2 billion for CitiGroup and $3 billion for Wells Fargo. The number for JPMorgan Chase could grow by an additional $3.5 billion if more loans from its Washington Mutual subsidiary do not work out. Whatever the case, the numbers suggested by Goldman Sachs can be easily absorbed by the larger banks.
But what if mortgage investor claims are more successful? What if settlements and remedies against dozens of lenders and Wall Street firms amount to hundreds of billions of dollars? Or more? Massive losses will need to be written off immediately so it will no longer make sense for lenders to have a foreclosure inventory or to wait for higher prices. Instead — under inevitably new management — the fresh strategy will be to clean up the books, dump REOs, speed short sales, blame old management, regain public confidence and move on.
____________________
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.
