Last week, I argued against Congressional proposals to "get government out of housing" by killing government backed mortgage firms Fannie Mae and Freddie Mac. Now comes fresh evidence that buttresses my view that the private sector just isn't ready to take up the slack if the two mortgage giants are eliminated.
This week, Redwood Trust, one of the largest issuers of private residential mortgages, released details of its latest securitization package. The good news is that it was Redwood's 11th deal of the year, which shows private investors are coming back into the mortgage market totally dominated by Fannie and Freddie over the past five years. The bad news: A close reading of the package shows that private investors are still looking for ultra-safe, plain vanilla loans to pool and sell as securities. And they're harder to come by.
No one doubts that since Fannie and Freddie were taken into conservatorship in 2008, private capital in mortgage markets has been scarce. Having lost billions when the housing bubble burst, private investors were in no hurry to resume lending. That's why Fannie and Freddie were forced to expand their lending, from roughly 40 percent of the market pre-crisis to 77 percent in 2012.
Everybody knows we won't return to "normalcy" in housing until their footprint shrinks and that of private investors expands. But House Republicans, who imagine that housing markets can get along just fine without the government guarantees Fannie and Freddie offer, might want to take a good look at Redwood's latest package. It offers insight into the current appetite of private investors for mortgage risk.
Redwood specializes in jumbo loans – loans typically taken out by higher-income families for amounts larger than Freddie and Fannie will guarantee. It steers clear of riskier loans where borrowers have lower credit ratings or less cash to put toward a down payment. For starters, Redwood's latest collection of mortgages was the smallest in loan volume of the year, even as the number of lenders in the pool rose. That suggests a dwindling pool of jumbo loans to low-risk borrowers.
One likely explanation is the recent spike in interest rates, which has slowed loan refinancing. In any case, two rating agencies, Kroll Bond Ratings and Fitch Ratings, gave the Redwood package AAA rating, indicating a low probability of default.
As Megan Hopkins reports on Housing Wire, the Redwood deal is very similar in risk characteristics (re: super conservative) as previous pools of mortgages it has packaged over the last two years. However, there is a slight uptick in loans that have less equity, yet are still considered quite safe. In other words, Redwood has had to give up a little safety to find enough loans to securitize.
Moreover, the Fitch report shows that jumbo loans that the private investors Redwood needs are willing to invest in are concentrated in just a few states. California was the largest state in this last pool and the one before that, with its share increasing to 46.9 percent from 40.9 percent, according to the HousingWire article. Fitch also noted that the pool was entirely comprised of 30-year fixed rate mortgages. Even among affluent homebuyers, and despite historically low interest rates, the good old 30-year fixed is still the favorite. (While Redwood shows fixed rates can be made available by private lenders on a smaller scale, this is yet another reason we still need the GSEs.)
If private lenders are willing to take on more risk and issue loans the government won't, what's the problem? The characteristics of the borrowers in the Redwood Trust transaction show you may be able to replace some of the loans that the government guarantees with private capital right now. And to be sure, pending regulatory actions (for example, on the qualified residential mortgage rule) and the prospect of abolishing the GSEs are also holding private capital back. That's why it's at best premature, and at worse an ill-fated idea, to eviscerate the two mortgage giants.
So let's applaud private lenders like Redwood and a few others for venturing back into mortgage markets. But the bottom line is these jumbo loans mirror the loans currently being guaranteed at the GSEs, and those pose zero systemic risk. Swapping private lenders for loans the GSEs are currently making at the high end of their market doesn't really accomplish anything. Even in a jumbo market that doesn't compete with the government to take on a little more risk; we are far from opening the doors to expanding more credit outside of pristine, ultra safe mortgages which are already being made.
What we need is for both private capital and Fannie and Freddie to start taking on more appropriate risk – to deliver credit to middle class borrowers with lower but still responsible credit scores and less money to put down. The pendulum swung too far, and the market has plenty of room to take some risk without creating a new bubble.
Jason R. Gold is director of the Progressive Policy Institute's "Rebuilding Middle Class Wealth Project" and senior fellow for financial services policy. Keep up with his work at PPI here and follow him on Twitter at @PPI_JGold.
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