SPECIAL REPORT: During the summer of 2007, as the housing market began to show significant signs of fraying, then-President George W. Bush did not initially offer any commentary on the growing problem. Indeed, the president had nothing to say publicly until a brief exchange with reporters on Aug. 8, 2007, when he was specifically asked about the rising foreclosure levels across the country. The president responded, ‘Obviously, anybody who loses their home is somebody with whom we must show an enormous empathy.’
When the collapse of Lehman Brothers occurred in September 2008, the Bush administration had more to offer than mere empathy. The Troubled Asset Relief Program (TARP) was quickly authored by then-Treasury Secretary Henry Paulson and ramrodded through Congress – which was no mean feat, considering the lame duck Republican administration faced a skeptical Democrat-controlled Congress.
TARP was designed to purchase or insure up to $700 billion in assets and equity from the nation's major financial services institutions – the so-called ‘too-big-to-fail’ entities that gave the impression of being too close to failing. Steve Horne, founder and president of Wingspan Portfolio Advisors, based in Carrollton, Texas, believes this endeavor sorely underestimated the enormity of the problem lurking within the portfolios of the too-big-to-fail institutions.
‘Paulson did not have enough money in the world to buy all that crap,’ he says.
But TARP made no provisions for the housing market. S.A. Ibrahim, CEO of Philadelphia-based Radian Group Inc., believes this omission was a major mistake.
‘When TARP funding was first given to bankers, I wished there was a provision for some of that liquidity to be directed to the housing market,’ he says, ruefully. ‘For the most part, the money went to strengthening the balance sheets of the banks.’
The administration kept the problems facing individual homeowners at arm's length for the remainder of Bush's presidency. In January 2009, Barack Obama's new administration and the Democrat-controlled 111th Congress took aim at the problems facing both homeowners and the nation's mortgage lenders. The result was a range of new laws, regulations and government agencies that were designed to bring stability and security to a tumultuous environment.
Fast-forward to today, however, and it appears that the majority of the federal legislative and regulatory efforts have not brought about their intended results. According to Len Israel, president of Santa Ana, Calif.-based Mission Hills Mortgage Bankers, a lack of significant victories could be blamed on the fact that President Obama and the 111th Congress came into the crisis too late.
‘The horses were out of the barn by the time the government started to begin to understand the depth of the problem created over the years,’ says Israel. ‘Sadly, the credit ratings assigned to debt instruments were far off in terms of measuring the relative credit risk and greed drove investors to grab the high returns found in derivatives. These models did not include scenarios involving a national downturn in housing.’
In reviewing the federal government's intervention, two recurring strains become visible: positive outreach that is constantly laced with difficulties, and ambitious programs that never quite hit their intended targets.
Following the downfall of Lehman Brothers, the private-label market seemed to evaporate overnight. Housing finance became the near-exclusive bailiwick of the federal government, and a number of federal programs that were all but marginalized during the peak of the housing bubble – most notably, the Federal Housing Administration (FHA) and the residential mortgage programs of the Department of Agriculture and the Department of Veterans Affairs (VA) – were suddenly called on to fill a new void.
‘Without federal intervention, we'd be in Great Depression 2.0,’ says Dr. Susan Wachter, professor of real estate and finance at the Wharton School of the University of Pennsylvania, who credits the FHA in keeping liquidity in the housing market. ‘This is the success story. It is a tribute to the people at FHA, who have not been given the recognition they deserve. They've been working under war conditions.’
Winthrop Watson, president and CEO of the Federal Home Loan Bank of Pittsburgh, concurs. ‘If there was no federal response, we would have had a much sharper fall with a lot more pain.’
‘To this day, the FHA, VA, Fannie Mae and Freddie Mac have provided the market with liquidity,’ says Todd Hempstead, senior vice president of investor relations at CMG Mortgage, headquartered in San Ramon, Calif. ‘We've not seen private capital during this time.’
But existing government entities could only go so far and accomplish so much. Dr. Linda Hooks, professor of economics at Washington & Lee University in Lexington, Va., observes that the depth and scope of the housing market's woes defied a quick and easy answer.
‘This is a complex problem without an easy solution,’ she explains. ‘The housing market is not like a typical market. Take the corn market, for example – if you have a drop in market prices, farmers plant more corn next year. You can't do that with housing.’
The Obama administration and Congress sought to jump-start the market with a first-time home-buyer tax credit. The initial tax credit was proposed for $15,000, but it was whittled down to $8,000 and signed into law in February 2009 as part of the American Recovery and Reinvestment Act.
Originally planned to run through October 2009, the tax credit's closing deadline was later extended through September 2010. At first, it appeared to achieve its goals with uncommon speed and depth.
‘You saw much more robust house-purchasing than you would have otherwise,’ says Paul Merski, executive vice president and chief economist at the Independent Community Bankers of America (ICBA).
‘The first-time home-buyer tax credit worked very well,’ adds Scott Reid, CEO of Bedford, N.H.-based Alpine Mortgage LLC. ‘We definitely saw an uptick in business.’
Indeed, the National Association of Realtors reported that the tax credit was responsible for September 2009's existing-home sales reaching their highest level since July 2007, when the housing market began to tank. Yet the tax credit's effectiveness was, ultimately, ephemeral.
‘The first-time home-buyer tax credit had an impact,’ says Avi Naider, chairman and CEO at ACES Risk Management Corp., based in Fort Lauderdale, Fla. ‘But when the program was taken away, the housing market slowed down. It was an artificial stimulus.’Â
Hit and miss
The temporary uptick in housing sales created by the tax credit ran parallel to another concern: the absence of a vibrant secondary market. Wall Street withdrew from the secondary market following the Lehman Brothers debacle, leaving Fannie Mae and Freddie Mac as the dominant secondary-market players.
But those government-sponsored enterprises (GSEs) faced their own financial catastrophes, brought about by reckless and inept management. A week prior to the Lehman Brothers collapse, the Federal Housing Finance Agency seized the GSEs and placed them into federal conservatorship, which enabled them to continue operations with a constant infusion of taxpayer funds.
Although placing the GSEs in conservatorship kept the secondary market alive, it created a new dilemma: how long would the federal government fund the secondary market? The Obama administration initially promised to offer a GSE reform plan by February 2010, but when the deadline arrived, it abruptly delayed the plan for another year. When its second deadline occurred, the administration sent three different GSE reform proposals to Congress without specifically endorsing any of them.
In turn, the Republican leadership in the House of Representatives offered several plans. To date, there has been no consensus behind a single plan, and the U.S. taxpayers continue to fund the GSEs.
‘If, three years ago, someone said, 'Three years from now [the GSEs] will still be in conservatorship,' I would be incredulous,’ says Edward Pinto, resident fellow with the American Enterprise Institute in Washington, D.C. ‘Their conservatorship has no deadline – it could go five years or eight years. Once it is gone past three years, why not? What is there to stop it from being a perpetual conservatorship?’
ICBA's Merski notes that the failure to resolve the GSE question only fuels residential mortgage lenders' agitation.
‘[The GSEs] are still the primary source for community banks to securitize their mortgages,’ he explains. ‘That concern is lingering – whether community banks can continue to do mortgages and securitize them in a manner that makes their balance sheet work.’
But even though the government had no clue on how to handle the GSEs, it did have ideas on how to reconfigure the residential mortgage market. Actually, it had 2,300 pages worth of ideas, known as the Dodd-Frank Act.
Within the financial services industry, the Dodd-Frank Act sparked endless debate. Certain aspects of the voluminous legislation had supporters – for example, Marx Sterbcow, managing partner of New Orleans-based Sterbcow Law Group LLC, observed that the legislation brought a degree of order to the often-chaotic interpretation of the Real Estate Settlement Procedures Act (RESPA).
‘From a RESPA component, Dodd-Frank was desperately needed in the enforcement area,’ Sterbcow says. ‘Before, there was in-fighting between government agencies. Now, by putting all agencies into one organization on the enforcement side, it is very good. We expect to see a significant amount of enforcement, compliance-wise. And companies that continue to do business as they did for years will be in for a rude awakening.’
‘The lack of underwriting was a major contributor in the frenzy to push out most product,’ adds Edward Kramer, executive vice president at Minneapolis-based Wolters Kluwer Financial Services. ‘The Dodd-Frank Act is attempting to correct that. If you don't assess a borrower's ability to repay a mortgage, you have to retain some risk.’
However, since its passage in July 2010, one aspect of the Dodd-Frank Act monopolized the attention of the financial services industry and the political debate: the creation of the Consumer Financial Protection Bureau (CFPB) and its regulatory authority over mortgage banking. Dominating the debate was the polarizing impact of the CFPB's architect, Harvard University professor Elizabeth Warren, who repeatedly promised that the new entity would function as a ‘cop on the beat’ when dealing with the financial services industry.
For nearly a year, Warren served as the de facto head of the bureau without being nominated to become its first director. Rather, she held advisory titles linked to the White House and the Treasury Department. President Obama ultimately bypassed Warren and nominated former Ohio Attorney General Richard Cordray to become the first CFPB director. However, Sterbcow wonders if the bureau will be able to maintain a full and dedicated staff – particularly in view of a Washington climate that is pushing to cut federal programs.
‘The real issue with the CFPB is funding,’ he says. ‘There may be problems in hiring qualified people, because some folks do not want to join the CFPB and find there's no funding. And right now, it is an organization in flux with no real leaders at helm because of politics.’
Kramer believes that Warren's high visibility in the year leading up to the CFPB's official opening on July 21 was an unfortunate distraction. ‘So many in the industry were so focused on one person rather than in the agency,’ he says. ‘We don't know how it is going to enforce and/or write rules and regulations.’
More recently, another aspect of the Dodd-Frank Act has begun to rattle lenders: new risk-retention proposals that require lenders and securitizers to retain 5% of loan risk. Loans originated under this proposal would carry higher costs and fees for borrowers, unless they qualify for a Qualified Residential Mortgage (QRM). But a QRM would require a 20% down payment and a credit history that was never blemished with delinquencies lasting 60 days.
Mission Hills Mortgage Bankers' Israel considers the QRM regulations to be a federal equivalent of a kiss of death to the housing market.
‘The regulatory proposal making qualified mortgages require as much as a 20 percent down payment from borrowers, as well as provide for other underwriting requirements, would be 'game over' in that the rule would put homeownership out of reach for many creditworthy families,’ he says. ‘According to the Joint Center for Housing Studies of Harvard University, the combination of higher income, down payment, and credit score requirements in today's broader mortgage market will prevent many borrowers from getting the loans today that they would have qualified for in the 1990s – before the housing boom we experienced.’
Bob Dorsa, president of the American Credit Union Mortgage Association, concurs.
‘QRM is the 800-pound gorilla in the room,’ he says. ‘Look back just two years – only one out of five people who obtained mortgages in 2009 would qualify today under QRM standards. We have to take a realistic approach to this – millions of people might have a few scars and stains on their credit histories, but holding them to the highest level of laws will delay a housing recovery for years.’
Even the FHA raised its concern on the proposed QRM definition. In congressional testimony delivered in April, Acting FHA Commissioner Bob Ryan warned that the QRM definition ‘has the potential to create false-positive situations that deny creditworthy borrowers affordable loans in this class.’
However, Wingspan's Horne believes there is value in the risk-retention proposal.
‘You need to understand that on the origination side, there is an extremely strong desire to return to the status quo – as if this never happened,’ he says. ‘Some folks say it will never happen again. No, it can happen and will happen.’
For the homebound
But what about the homeowners who were still barely hanging on to their property? Starting in 2009, the federal government conjured up an alphabet soup of efforts designed to help homeowners stave off foreclosure: The Home Affordability Modification Program (HAMP), HOPE for Homeowners (H4H), Home Affordable Refinance Program (HARP) and the Neighborhood Stabilization Program (NSP) all came into play.
But after more than two years in operation – which included attempts by House Republicans to shut down HAMP and NSP – President Obama admitted that the programs had fallen far short of their goals. In a July 6 national Twitter-sponsored town-hall meeting, the president glumly stated that he was ‘going back to the drawing board’ to continue working on strategies to jump-start the stagnant housing market. He also warned that ‘no federal program is going to be able to solve the housing problem’ and added, ‘We should be able to make some progress on helping some people.’
What went wrong? According to Gibran Nicholas, chairman of the Ann Arbor, Mich.-based CMPS Institute, the government's approach to aiding homeowners facing foreclosure was doomed from the start.
‘It is all aimed at the wrong issue,’ he explains. ‘It has been aimed at monthly payments and not negative equity. If you have 20 percent to 30 percent negative equity, what is the point of making loan payments?’
Chris Sorensen, founder of the Los Angeles-based Homeownership Education Learning, adds that the federal government exacerbated the problem by insisting on paper-heavy bureaucratic solutions.
‘It encouraged borrowers – who know nothing about underwriting guidelines – to submit income and expense declarations, and budgets that forced the servicers to request more and more paperwork,’ he says. ‘The government passed laws that forced honest entrepreneurs out of the business of helping the public, and left it up to well-meaning but uneducated nonprofits and Tier 1 employees to create an even bigger logjam in a blind-leading-the-blind scenario.’
‘The government has responded by driving while using the rearview mirror,’ complains Wil Armstrong, chairman of Denver-based Cherry Creek Mortgage Co. ‘Its refi program is not working. There were underwhelming responses with HAMP and HARP. The home-buyer tax credit was a perversion of what went on in the underlying market. We have a hodgepodge of new regulations and more bureaucracy and red tape. We should have had more enforcement of the existing laws that were broken.’
‘With the H4H program, there were not enough investors willing to discount the mortgages,’ recalls Ken Clark, president of First Guaranty Mortgage Corp., headquartered in McLean, Va. ‘They were still playing hardball. Plus, the process was too hard to deal with – it took three to four weeks to get one loan approved. The original idea was good, but it was too cumbersome to be successful.’
Dr. Gregory Price, chairman of the economics department at Morehouse College in Atlanta, also points out that many of these programs lacked adequate funds, thus limiting their scope from the beginning.
‘The federal government has probably done too little,’ he acknowledges. ‘But given fiscal realities, the federal government cannot afford to take on more debt.’
What was left undone
However, there were corners of the real estate finance world that the federal government opted to leave alone.
‘The government has not provided liquidity for jumbo and nonconforming loans,’ observes Chad Santander, director of secondary marketing for Bay Equity Home Loans, headquartered in San Francisco. ‘They didn't feel it was their responsibility.’
However, Santander believes this sector can recover without federal assistance. ‘If there are profits to be made, that market will come back,’ he says.
Also missing was federal aid to a sister industry: commercial real estate. Jake Clopton, president of Chicago-based Clopton Capital, was not surprised by the lack of government attention to ailing commercial property markets.
‘Government has always been more focused on the consumers,’ he says. ‘There is also the stigma of a bailout. People would have gone crazy if there was an aid program for commercial real estate when people were losing their homes.’
Buck Hawkins, residential president of the California Mortgage Bankers Association and senior vice president of capital markets at Los Angeles-based Castle & Cooke Mortgage LLC, wonders why the Obama administration did not follow the example of another president who faced a housing market crisis: Franklin D. Roosevelt, whose administration launched the Home Ownership Loan Corp. (HOLC), which refinanced mortgages by selling bonds to lenders in exchange for the problematic mortgages.
‘By the time the HOLC shut it doors in 1951, it turned a profit,’ says Hawkins. ‘Sometimes, the easiest and best solution is what was done before.’
Washington & Lee University's Hooks recalls a similar federal endeavor for another crisis: the Resolution Trust Corp. (RTC), which was created in the aftermath of the late-1980s savings-and-loan industry meltdown.
‘Recovery takes time, and a lot of it,’ she says. ‘The RTC ultimately bought time. It held a lot of real estate until the market recovered and gently introduced that real estate back to the market.’
But Hawkins points out that yesteryear's patience no longer exists. ‘That did not happen now because of the negative public perception of bailouts,’ he says. ‘And we also learned that the government was being selective in whom to help – who has the most risk to the market. That is the reason Bear Stearns was helped out and not Lehman Brothers.’
In many ways, the federal government's approach to the housing market crisis is still a work in progress. In his July town-hall meeting, Obama admitted that he did not have a steady hand on the problem from the beginning of his term.
‘I didn't realize the magnitude, because most economists didn't realize the magnitude,’ he said, noting that one of his missteps during his administration was not adequately explaining that ‘it was going to take a while to get out of this.’
However, Jim Kirchmeyer, CEO of Buffalo, N.Y.-based Kirchmeyer & Associates, adds that the government's ongoing response recalls Ronald Reagan's celebrated wisecrack about the nine scariest words in the English language: ‘'I'm from the government and I'm here to help,'’ he says. ‘Yeah, it's a joke!’
Tomorrow: Part three of this four-part series will examine borrowers' and mortgage bankers' problematic behavior, which further exacerbated the housing market's ongoing crisis.