When Robert M. Pardes talks, people should listen. After all, he knows more than a thing or two about the mortgage banking industry. A CPA and attorney with 20 years of management experience in real estate and financial services, he is the former executive vice president and chief lending officer with OceanFirst Bank in Toms River, N.J., and the former president and CEO of Columbia Home Loans LLC in Valhalla, N.Y.
MortgageOrb caught up with Pardes to get his views on the state of the national economy in general, the mortgage banking industry in particular, and the possible steps of steering the country back into financial good health.
Q: Has the Fed's slicing at interest rates made any impact on the economy?
Pardes: Even a layman can conclude that the actions of the Federal Reserve in cutting short-term rates has done little to provide relief to deteriorating economic conditions. To the contrary, it is easier to conclude that the 225 basis points (soon anticipated to be 275 basis points or 2.75%) of rate cuts over the last six months has been counterproductive in addressing the disease infecting the economy.
The proof in the pudding is that the rate for fixed-rate mortgages is higher today than at the beginning of the year, and slightly higher than one year ago. Thus, the Fed's actions have not assisted in increasing the purchasing power of potential home buyers or reducing the carrying costs of existing homeowners through mortgage refinancing. One exception is any cost savings realized by homeowners with extended home equity lines of credit.
On the other hand, the Fed's actions relative to rate cuts have spawned inflationary pressures evident in the considerable increases in oil prices, food and other commodities. Has there been a fundamental shift in our dependence on foreign investment in our debt instruments (which includes the considerable financing needs of Fannie Mae and Freddie Mac)? Of course not.
Any perception that significant rate cuts could mitigate future defaults relating to adjustable-rate nonprime loans and negative amortization adjustable-rate mortgages (ARMs) is clearly misguided. For the most part, rate adjustments relating to the toxic subprime and Alt-A mortgages dominating the headlines are tied to the London Interbank Offered Rate (LIBOR), an index that the Fed has little direct influence over. Option ARMs are tied to the moving 12-month average of the one-year Treasury, a lagging index that would considerably dilute the near-term benefits of rate cuts. Here again, the Fed's actions are virtually impotent in addressing a key concern weighing heavily on the prospects of an expedient economic recovery.
With the Federal Reserve telegraphing a willingness to accommodate sizeable future rate cuts while most other central banks have stated intentions to stand pat or increase rates, the risk of continuing devaluation of the dollar against other currencies is considerable. It's no wonder foreign investors require a premium to cover the anticipated slide in the currency to maintain the level of demand for dollar-denominated debt.
Q: Is the nonprime market dead, or is it possible to resurrect it?
Pardes: No doubt, the proliferation of aggressive nonprime mortgage products inflated housing demand in recent years – fueling the current crisis. At the peak of the bubble, nonprime or exotic mortgage products made up as much as 40% of total purchase money financings.
Nonprime mortgages have been around for many years prior to the peak of the real estate bubble. While comprising a significantly smaller population of total purchase money financings (10%-15%), the availability of the historically less aggressive nonprime mortgage products supported a similar percentage of core housing demand and served to bridge the socioeconomic diversity that has been the hallmark of our nation's homeownership objectives. Healing the housing market requires resurrection of the more modest nonprime industry that predated the housing bubble, as the absence of this component is artificially depressing demand and contributing to falling values.
Given the total absence of liquidity for private-label mortgage securities, resurrecting a downsized nonprime financing industry is a tall order and is perhaps the area most in need of fiscal and regulatory support. The following steps would be intended to prime the private-label mortgage securities market until liquidity returns:
- Provide a tax exemption for interest relating to newly issued (and presumably more transparent) nonprime residential securities that meet defined parameters; and
- Impose a moratorium on the mark-to-market rules for these securities.
Tax incentives are necessary in order to elevate the after-tax yields for investors while maintaining the nominal nonprime rate of the underlying mortgage within a reasonable range to support affordability. Imposing a moratorium on mark-to-market for defined securities would mitigate the Catch-22 that fixed-income fund managers find themselves in under the current climate.
Q: The hot button issue around Washington has involved borrower bailouts. Where do you see this going?
Pardes: There has been much debate on the propriety of a taxpayer bailout for homeowners. Proposals have been tossed around that include subsidized mortgages for distressed homeowners, expanding the power of state agencies to issue tax exempt bonds, and expanding the product menu purchased by Fannie Mae, Freddie Mac and the Department of Housing and Urban Development (HUD) to support refinances of outstanding nonprime mortgages.
A surgical approach to assist the population of borrowers deserving of assistance, would be far less costly and capable of more immediate impact than most of the other proposed alternatives. A HUD-insured mortgage product that would allow for an immediate subsidy in the form of a principle reduction, with the opportunity for taxpayers to recoup that subsidy over time through shared appreciation at the time of sale, can be funded at an estimated cost of no more than $30 billion (before recoupment) – far less than the $150 billion of rebates that are likely to have considerably less impact in driving economic recovery.
It is strongly urged that HUD and the existing national housing finance system be the tool for distribution of any remedial assistance. Fannie Mae and Freddie Mac are mired in too many regulatory, capital and political issues to be effective at this time.
Additionally, it was the efficiency of the existing distribution system that allowed for the proliferation of the products that triggered the housing crisis. It is this same system that can and should distribute remedial measures through a mature partnership among HUD, lenders and servicers. All that is needed is a defined product, the right economic incentives and proper guidance, and the private sector can and will respond on a far more timely and cost-effective basis. By the time local agencies and tax-exempt bonds actually hit the market, the crisis will have become more severe and the cycle unnecessarily prolonged.
Q: So, how can we hasten the road to recovery?
Pardes: Measures that effectively treat the root cause will improve the chances of shortening this painful cycle. Likewise, actions that create a considerable risk of extending the cure period are counterproductive and should be avoided.
With this in mind, I would urge immediate abandonment of all regulatory proposals that pose the risk of promoting delay or otherwise add complexities to markets that are already burdened by uncertainty. Resources should also be dedicated to remedial steps that will foster acceleration in the recycling of distressed housing inventory, including the shared appreciation program described above.
Legislation that would empower the courts with greater discretion in bankruptcy proceedings cannot possibly be an approach to getting this economic cycle behinds us as swiftly as possible. Since when have the courts ever been considered the most expedient and cheapest way to resolve adversity?
Greater discretion promotes factual inquiries, and allows for attorneys to devise creative strategies that inevitably add expense and delay. Additionally, the added uncertainty as to creditors rights relating to mortgages certainly does not support the principal of promoting liquidity for the related capital markets.
Other regulatory proposals that need to be quickly abandoned are assignee liability, moratoriums on foreclosure and interest rate freezes – all of which undermine recovery of the capital markets without providing any real path to expedient resolution. Administer the medicine, bear the pain and let's move on to better times as soon as possible.