GSE REFORM MADE SIMPLE: (CASH-OUT) REFINANCES VS. HOMEOWNERSHIP LENDING

November 13,2013Joel S Singer, CEOCalifornia Association of Realtors

THE PREMISE : SHOULD REFINANCES BE EQUIVALENTLY GUARANTEED AND PRICED TO HOMEOWNERSHIP LENDING?From the twin standpoints of risk and privatization, GSE reform should begin here…

GSE MISSION STATEMENTS &GOVERNMENT COMMITMENT TO HOMEOWNERSHIP

Fannie Mae & Freddie Mac:Stewards of Homeownership

Chartered by Congress to provide liquidity, stability, and affordability to the U.S. housing and mortgage markets

Fannie Mae: Our mission is to tear down barriers, lower costs, and increase the opportunities for home ownership and affordable rental housing for all Americans. Because having a safe place to call home strengthens families, communities, and our nation as a whole.

Freddie Mac: Freddie Mac was chartered by Congress in 1970 with a public mission to stabilize the nation's residential mortgage markets and expand opportunities for homeownership and affordable rental housing. Our statutory mission is to provide liquidity, stability and affordability to the U.S. housing market.

THE RISK ASPECT: CAUSES OF THE FINANCIAL CRISIS

Caveats: Yes, There Were A Myriad Causes Underlying the Financial

Crisis • Extremely low interest rates • High-yield MBS’s looking increasingly

attractive• Credit rating agencies gave AAA to junk • Derivatives – complex & unregulated• 1998: Glass-Steagall repealed• Lend to sell to “securitizers” model meant

no one was focused on credit quality• Proliferation of “innovative” mortgages with

much higher default rates than 30 Yr FRM

THE REALITY: AN EPIDEMIC OF “CASH-OUT” REFI’S

What led to the Refinancing Boom?

• Three trends in the U.S. housing market• Rising home prices• Falling interest rates• More “efficient” refinancing• Reduced Documentation• Inflated on no appraisals• Marketing

Mortgage Rates Dropped Significantly in Early 2000’s

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130%

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9% FRM ARM Federal Funds

SERIES: 30Yr FRM, 1Yr ARM, Federal FundsSOURCE: Federal Home Loan Mortgage Corporation

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$600,000 California CA Price Trend US

Median Home Prices Surged in the Mid 2000’s• 1970-2012

SOURCE: CALIFORNIA ASSOCIATION OF REALTORS®

SERIES: Median Price of Existing Single Family HomesSOURCE: CALIFORNIA ASSOCIATION OF REALTORS®

Refi and Cash-Out

•Between 2006-2008 3.5 million homeowners refinanced at least twice

• In 2006 – 86% of borrowers who refinanced took out cash. $320 B

Mortgage Originations: 1990-2013

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Refinance Share (%) Purchase Share (%)REFINANCE/PURCHASE SHARE

SERIES: Mortgage OriginationsSOURCE: Mortgage Bankers Association of America

Home Purchase Loans vs. Refinance Loans

Cash-Out Refinance Peaked in 2006Q2 at $84 billion

89% Took “Cash-Out” At Refinance in Q3 2006

Rates of Seriously Delinquent Cash-Outs Higher

Year Type Portfolio GSEs

2005 And Earlier

Purchase 21.8% 4.1%Refi 14.4% 2.8%

Cash-Out Refi 23.8% 3.2%Other 10.4% 3.7%Total 20.2% 3.5%

2006-2008

Purchase 27.6% 14.2%Refi 29.8% 15.9%

Cash-Out Refi 31.7% 14.2%Other 20.0% 16.3%Total 28.8% 14.6%

2009 And After

Purchase 0.5% 0.3%Refi 0.7% 0.6%

Cash-Out Refi 0.5% 0.5%Other 1.8% 0.3%Total 0.6% 0.5%

Total

Purchase 18.4% 5.6%Refi 8.5% 3.1%

Cash-Out Refi 19.5% 4.6%Other 15.5% 5.5%Total 15.0% 4.5%

WHAT DID THIS LOOK LIKE IN REAL LIFE?

1872 W. Admiral, Anaheim CA 92801

•3 bd, 2.5 ba, built in 1982• Sept 2005: Purchased for $594,000 with 30% downpayment• April 2006: Added a second for $57,000• October 2006: Refinanced the second into a new second for $100,000•2010: Default•October 2010 value: $364,000

1572 W. Orangewood, Anaheim, CA 92802

•3 bd, 2 ba, 2,016 sq ft built in 1977•June 2003: Purchased for $455,000 with 30% down•March 2004: Added a second for $75,000, a third for $90,500 and a fourth for $80,000 •Within one year of purchase the property had $565,000 in debt on it!•2010: Default•October 2010 value = $442,000

8871 RegalAnaheim, CA 92804•3 bd, 2 ba, 1,314

sq ft built in 1956•2005: Sold for $568,000 •2007: Purchased as REO for $417,000, zero downpayment•2010: Default• October 2010 value = $367,500

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2414 E. UnderhillAnaheim, CA 92806•3 bd, 2 ba, 1,459

sq ft built in 1957•2006 Purchased for $640,000with piggyback financing: $500,000 first and $140,000 second, i.e. zero down•2010: Default•October 2010 value = $387,000

WHAT MIGHT THIS LOOK LIKE IN THE AGGREGATE?

NBER Simulation: Without Cash-Out Refi, Outstanding Mortgages Totaled over $4 billion by December 2008 …

Source: National Bureau of Economic Research – NBER Working Paper Series: Systemic Risk and The Refinancing Ratchet Effect (Sept 2009)

No Cash-Out Refinancing

$10,154

$4,105

NBER Simulation: With Cash-Out Refi, Outstanding Mortgages Tripled…

Source: National Bureau of Economic Research – NBER Working Paper Series: Systemic Risk and The Refinancing Ratchet Effect (Sept 2009)

Cash-Out Refinancing

$16,570

$12,018

Cash-Out Refinancing Increases the Number of “Underwater” Homeowners

Cash-Out Refi No Cash-Out Refi

Outstanding Mortgages $12,018 billion $4,105 billion

Value of Houses Used as Collateral $16,570 billion $10,154 billion

Aggregated Loan-to-Value 72% 40%

% of Homes in Negative-Equity Territory 18% 3%

Estimated Losses Absorbed by Lenders (from June 2006 to December 2008) $1,543 billion $280 billion

Note: The data in the above table reflects figures as of December 2008. Source: National Bureau of Economic Research – NBER Working Paper Series: Systemic Risk and The Refinancing Ratchet Effect (Sept 2009)

A NOTE ABOUT TEXAS

Texas Model

• In Texas, cash out and home equity loans cannot exceed 80% of the home’s appraised value

• Result: significantly lower delinquency and foreclosure rates

Subprime Delinquency Rises More Slowly in Texas

Note: Serious delinquencies are mortgages more than 60 days past due or in foreclosureSources: Mortgage Bankers Association; Federal Housing Finance Agency; Federal Reserve Bank of Dallas

Differences between Texas and U.S. in Mortgage Characteristics

Sources: First American Loan Performance data from Federal Reserve Bank of New York (August 2008); Federal Reserve Bank of Dallas

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WHERE DO WE GO FROM HERE?

A FAR MORE TARGETED AND RATIONAL APPROACH TO DOWNSIZING THE GSE’S1) Differentially Price Refi’s2) Differentially Guarantee Refi’s

THANK YOU!www.car.org/marketdatajoels@car.org