Here is Another Reason to Get the GSEs Off the Books

Sen. Boxer has proposed using the government’s control over Fannie and Freddie to change the way they process refinances. According to HousingWire GSEs have about 2 million mortgages in the mortgage-backed securities they own that would be targeted for preferential treatment, relative to similar mortgages that are not owned by the GSEs.

These targeted homeowners would have to be current on their mortgage (so not those who have strategically defaulted) but underwater as a result of falling housing prices. The bill would “eliminate the negative equity restrictions and the upfront fees Fannie and Freddie charge when evaluating current homeowners” so that these borrowers would refinance.

If a company wanted to do this, they could change their rules. If the GSEs thought it would be a good idea for their business to do this, in theory they could as well. But they haven’t. And neither have private firms. Somehow, Sen. Boxer thinks she knows the mortgage business better.

By using the power of law to direct business activity Sen. Boxer is doing what has been a fear of many over the past few years as Fannie and Freddie have languished in conservatorship, using legislative pressure for political gain.

There are good reasons why the GSEs have not pulled back fees or rules for not refinancing homes with severe negative equity. One reason is rules mandating homes not have LTVs higher than 125% (i.e. the loan is 125% of the value of the home, or a $125,000 loan for a $100,000 house). But if these homes are as underwater as Sen. Boxer argues, then many of them would exceed this threshold upon refinancing. Imagine a borrower putting 10% down on a $100,000 home (a 90% LTV). Assume that borrower has paid off 5% of the principal since purchase, so they owe $85,000. But home prices have fallen 30% to 40% in some areas. So now the house is only worth $65,000—which is an LTV of 130%. If the loan is refinanced it will have to be reappraised and the LTV will go from 90% to 130% (assuming the same principal but with a lower interest rate).

The HousingWire story quotes Sen. Boxer’s staff as suggesting the GSEs could push these loans out of MBS and into their portfolio after refinancing. But the porfolios are shrinking 10% every year according to the terms of the conservatorship, that is not a long-term solution.

In principle, being underwater shouldn’t necessarily be a bad thing for a homeowner, unless they want to sell. This bill is to help homebuyers refinance from their current terms, paying investors 6% or more, to today’s interest rates, which are as low as 4%. It isn’t going to keep people from defaulting necessarily, unless they’ve lost their job and can’t afford the payments they were once able to make with ease.

Investors would lose out in this situation and may be opposed. The GSEs could face balance sheet problems and seem to be opposed. But Sen. Boxer would get a political win.

Seriously, why do we still have these guys around?