REAL Trending Episode 51
Conversion of Fannie and Freddie to Publicly Held Companies, New Lending for Renters who Have Inconsistent Incomes
Also: Pressure on Brokerage Financial Results
REAL Trending Episode 51
Conversion of Fannie and Freddie to Publicly Held Companies
The federal government, under the Federal Housing Finance Administration, has proposed, after six to eight months of work, the complete restructuring of Fannie and Freddie, in the effort to get them off the balance sheet of the federal government, and to end the implied 100% guarantee of everything they do in the mortgage market.
Those who may not remember or recall, Fannie and Freddie, as a result of their decisions as a publicly held company back in 2006 and 2007, acquired $1.5 trillion, approximately, of junk mortgages, which caused them to default, which caused the federal government to have to inject nearly $180 billion to maintain their solvency. They put them into conservatorship, where they remain to this day.
Meanwhile, Fannie and Freddie returned to great profitability after the downturn, and have far more than paid back the $180 billion, and continue to pay virtually all their earnings to the federal government. It’s as if the federal government itself is still in the mortgage business.
Now, FHFA has proposed a new structure, where they are cut loose, for the most part, from any implied or warranted federal guarantee of their operations results. It is thought, strongly thought by many experts, that without the implied or warranted federal government guarantee, that rates would have to rise in the mortgage market, which as Mark Zandi commented, will cause mortgage rates, and likely fees, to go up once Fannie and Freddie are cut loose from the federal government and have to make it on their own.
Others think that after an initial period of time, rates may decline actually, as more competition enters the market, especially the secondary market, for mortgages, because certainly there are large financial institutions that would want a piece of the action, and if they’re set free to compete with Fannie and Freddie, in fact over a period of time, rates may come down.
Now, this author is not an expert in actually what happens in money markets at that level. Both sides have a compelling story to make. But this much is true: If I’m anybody that’s in the lending business, or acquiring financial securities, and I have the absolute, 100% money-back guarantee by the U.S. federal government, I’m going to do all kinds of things, as Fannie and Freddie showed us back in ’06 and ’07, to fight to gain market share, et cetera.
It is likely a good thing for the country that Fannie and Freddie be set loose, and that they don’t have a 100% implied guarantee by the federal government. Part of the proposals do maintain some kind of backstop, just not the full backstop that now is in place. I agree with Zandi. He’s an expert. He’s called the market many times correctly. We may see rates rise some, but in the long run, competition should drive rates and costs down, simply because there is far more money chasing far fewer great deals in the mortgage market today than ever before.
You may have noticed that the 10-year Treasury bill rate has dropped into the low twos. Mortgage rates have followed that down. A lot of that is due to lack of demand for the money. Where there’s competition as to how to lend that money safely and carefully, and there’s some kind of a backstop, likely everyone will benefit, including future generations who no longer are backstopping the entire U.S. housing market.
New Lending for Renters who Have Inconsistent Incomes
On a second story, an article talked about new lenders who are filling the gap for young families, most of whom are renters, who are in positions where their income may be fine for renting a kind of apartment or single family home, but it’s not consistent income. That is, it’s not regular and routine, and we all know, being in the business we’re in, that could include a lot of real estate agents, who don’t know from month to month exactly how many closings they’ll have and how much income they’ll have.
So on the surface, this is probably a good thing. It is certainly a need for it. There’s certainly a market for it, and you don’t really want to see major fed banks underwriting this kind of lending behavior. So, some people equate it to just a new form of payday lending. Call it what you will, it’s probably a service that’s needed, given the millions of young families who have inconsistent incomes and need stopgap financing to perhaps pay their rent.
On the other hand however, are we now beginning the process of underwriting behavior that promotes recklessness among people who either don’t have consistent income or really don’t have consistent income, as in they keep taking jobs and quitting them two months later, and go three more months without a job. Meanwhile, they have a lender backing them to make their rental payments. It’s reminiscent, once again, of an economy that once in a while says, “Well, there’s a need there, and there’s maybe some risk there, but we’re going to jump in and lend money to people who otherwise, wise lenders would not touch, for a variety of very, very good reasons.”
Question is, are there enough controls in place, either through banks or through their clients, short-term, if you’ll pardon it, payday lender types, who will carefully mete out this kind of credit to families whose incomes, or jobs, are inconsistent at best. The worst part is it can promote reckless behavior and put people more and more in debt and further behind in their payments. On the other hand, it’s likely very true there are millions of hardworking young families who don’t have consistent incomes, who do need, from time to time, stopgap financing capabilities to pay bills like their rent.
Interesting that while this is all going on, and lenders are filling the gap, we’re running a 300,000- to 500,000-unit a year deficit in household construction versus household formation. There are all kinds of numbers about this all over the country, but we’re certainly millions of units, pardon me, in deficit housing creation based on the number of households being created. Hence, we see rents rising and housing prices rising. It’s something that everybody should pay attention to, particularly lenders, because some people report that the lack of funding for medium to small lenders in local and regional markets explains in part the dearth of medium and small builders filling the gap left behind by the large production builders.
Pressure on Brokerage Financial Results
Our third topic has to do with brokerage financials. As some of the listeners may know, at REAL Trends, we perform between 20 and 25 valuations of brokerage companies a month, and have been doing so for several years. What we’re noticing in many cases is a deterioration in brokerage financial results. There are exceptions of course, but more importantly, we’re seeing many firms watching their margins decline or evaporate.
Now, ladies and gentlemen and friends in the brokerage community, and this also goes for agents as well, this is a soft slowdown. We’ve had 11 months in a row of declining existing home sales, but we’re not talking 10, 20, 30% declines. We’re talking a point, or 2, or 3, nothing drastic. We’ve commented before in this podcast series, it is time for brokers to focus on their financial statements, go through the general ledger line by line by line, and eliminate all costs not related to the recruiting of talent, the development of talent, and production of sales. Anything not related to that absolutely should be curtailed in these times.
We recall the period 1988 to 1993, we had a similar slowdown in housing sales. It wasn’t dramatic, 10, 12, or 15% below the prior years, and yet five of the 20 largest brokerage companies in the nation went out of business in that time, because they were not managing their costs. My point in talking to you today about this topic is that number one, we don’t see the basis for any rapid improvement in the housing market, even though mortgage rates have dropped below 4% again. Any recovery will be slow. Why? Lack of inventory and pricing.
So our two cents for anyone caring to listen to this today, in the next few days, or week, or 10 days, get together with your internal finance people, or your outside accountant, or your operating partner, or just a good business friend, and pull that PNL apart, and find out where you’re really spending your money, and that which doesn’t lead directly to some kind of income-producing activities, you need to consider carefully getting rid of it.
Learn more about industry trends, marketing, and technology strategies, as well as listening to past REAL Trending episodes, on our website, www.realtrends.com/blog/. This has been Steve Murray. Until next time.
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