Book notes of “The Mortgage Wars”

Book notes of the Mortgage Wars

I have just finished read the book “The Mortgage Wars” by Tim Howard. With great attention to detail, Howard charts business decisions over a five-decade span and leading up to the company’s downfall. Here are my takeaways of this book,

• P31 – As David Maxwell liked to say,”Fannie Mae was political to its bone marrow.”
• P31 – Fannie Mae’s 1954 charter, as amended in 1968, gave it the mission ” to provide supplementary assistance to the secondary market for home mortgages by providing a degree of liquidity for mortgage investments, thereby improving the distribution of investment capital available for home mortgage financing.”
• P32 – From the time it became a shareholder-owned company, Fannie Mae faced criticism and pressures from three main sources: free market advocates, actual and potential competitors, and the two principal bank regulators, the Federal Reserve and the Treasury.
• Here are the key reasons why big banks hate GSEs while small and middle banks like GSEs?
  • P89 – Small and middle-sized mortgage bankers saw GSEs as a helpful partner: whether through GSEs’ portfolio purchases or credit gurantees, GSEs made it possible for them to be in the business of originating (and servicing) mortgages, and GSEs interests rarely if ever conflicted.
  • P90 – Small and middle-sized banks and thrifts did not like GSEs portfolio business because it competed with theirs, but that abstract objection was outweighted by the fact that GSEs portfolio purchases and mortgage-backed securities guarantees were cots-effective ways for them to originate and profit from a greater volume of mortgages than they were able to own or felt comfortable owning.
  • P90 – The very large banks had a more serious problem with GSEs. GSEs dominant position in the secondary market was a major impediment to their growing ambitions in the primary market.
  • P90 – The large national banks saw residential mortgages as key to their success with the consumer Mortgages were by far the largest consumer loan market, and the biggest banks also had learned that a mortgage relationship with a customer led to greatly increased sales of their other retail products. The challenge they faced was
    distinguishing the mortgages they offered from everyone else’s. The majority of their mortgage customers wanted 30-year fixed-rate conventional conforming loans, and any lender making these loans wanted them to be eligible for sale in the secondary market, whether they intended to sell them immediately or not. In the 1990s, Fannie
    wishing to sell to us had to originate to our standards. That greatly limited their flexibility in customizing their products Making matters more difficult was the fact that even as lenders looked to put their own brand on mortgages, actions initiated by Johnson with our automated under writing, new products, and consumer advertising were expanding the visibility and footprint of the Fannie Mae brand.
  • P 90 –  It was a legitimate conflict. Fannie Mae and our largest lenders had different objectives as well as different business models. Our objectives were expanding the universe of borrowers who could qualify for and afford a “Fannie Mae mortgage,” reducing borrower costs, ensuring that our credit standards were prudent and consistently applied, and making money for our shareholders. Our largest lenders shared none of these. In addition, we were a wholesale institution in the secondary market; they were retail institutions in the primary market. We made our money primarily on volume. not margin or fee rates, We did not originate, so reducing the
    cost of origination did not lower our revenues as it did lenders. Because we and not the lender took the credit risk on the loans we purchased or guaranteed, we believed it was our responsibility to set reasonable credit standards and to be able to enforce those standards. We also believed that the growing concentration of primary mortgage lending among very large institutions worked to both our and borrowers’disadvantage, and we sought to use our technology and position the market to try to keep as many lenders in the game as we could.
  • P 91 –  In the battle for control over what types of mortgages were made and how they were originated, our and Freddie mac’s position as gatekeepers of the secondary market gave us the upper hand. Our largest lenders found that highly frustrating, and their response was to accuse us of overstepping the bounds of our charter by “blurring the line between the primary and secondary market. “But in reality there was no bright line, other than our not being permitted to originate. lenders’two biggest complaints involved our consumer advertising and our technology. Our advertising was aggressive (FreddieMac did not advertise), but we justified it as a means of promoting home buyer education and improving our image with consumers. Technology was a different matter. While we had made ourselves visible with our pledge to lower origination costs by $1, 000 per loan, the application of technology to the mortgage business eventually would have wrung out excessive costs no matter what we did, just as technology had advanced bank consolidation through the economies of scale it brought. We did not cause the technology revolution; we merely sought to use it to our and consumers best advantage.
    In congressional testimony in March 1998, mortgage industry consultant Tom Lamalfa summed up large lenders objections to us by saying, “They are siphoning most of the economic value from the mortgage business. “That was hyperbole, but the underlying sentiment was accurate: our presence made it harder for large primary market lenders to make the amount of money they wanted to in the mortgage business. An ad their fear was that unless they could stops In some way, we would continue to achieve our objectives at their expense.
•  P145 – The Wall Street Journal’s editorial board was well known for its free-market ideology, therefore, they strongly oppose GSEs.
• P191 – Receivership was an idea that began with Treasury and had been
  endorsed by the administration and Greenspan. It never had been on the FM Watch agenda. None of our competitors were pushing for it They wanted Treasury to have more control over us-so they could earn more profits at our or consumers’expense–but they wanted us to remain in business. Talk of a receivership provision also worried the rating agencies. Standard Poors, moody’s, and Fitch all were watching the Shelby bill closely for signs
  of a change in the relationship between the GSES and the government, and all warned that evidence of such a change could trigger a downgrade on our
  debt. Fitch and S&P specifically singled out receivership as a source
  of concern. S&p’s Mike Destefano stated the obvious: “Giving the
  regulator that kind of power over the GSES is not a good thing for
  debt holders.”
• P192 – the administration already had decided on a different approach to GSEs – Operation Noriega, which refers to minor harassment to major onslaughts of GSEs.
• P248 – Barron’s article is very critical to policy makers. Therefore, I need to read and study Barron’s more regularly. The basis for the barron’s article was a paper titled “Fannie mae Insolvency and Its Consequences”that had circulated inside the administration beforehand. On the day the article appeared, a copy of
  the paper was sent by Jason Thomas, a senior staffer at the National
  Economic Council, to Robert Steel, treasury’s undersecretary for
  domestic finance. Steel was a 28-year veteran of Goldman Sachs a trusted friend and advisor of Paulson, and Paulson,s point person on Fannie Mae and Freddie Mac issues. thomas’s brief transmittal memo to Steel read, “Attached is the document used as the sourcing for today’s barron’s article on the potential collapse of Fannie Mae This is for your eyes only. I send it only to help inform potential internal Treasury discussions about the potential costs and benefits
  of nationalization.
  Five days later, Steel rushed into Paulsons office
• P249 – The last shoot by John Paulson to kill GSEs. Paulson was worried about the market’s reaction to the news of the Bear Stearns rescue, and according to his memoir, On the Brink, he thought a positive announcement about Fannie Mae and Freddie Mac might have a calming effect. For months, Fannie Mae
  CEO Mudd and Freddie Mac CEO Syron had been negotiating with Steel, OFHEO director Lockhart, staff from the Fed, and key members of Congress and the administration over the terms under which OFHEO might reduce the 30 percent capital surcharge it had imposed on the two companies. Congress wanted more GSE lending, and the gses wanted it as well. but the gses were con-
  strained by capital. Steel and Lockhart had proposed reducing their surcharge provided they raised $1.50 to $2 in new capital for every dollar in existing capital a lower percentage surcharge freed up. Mudd and Syron had been holding out for better terms when Paulson intervened. A few hours before the Bear Stearns news was made public, Paulson asked Steel to arrange a conference call with Lockhart, Mudd, and Syron to resolve the capital issue. During this call
  Paulson convinced Lockhart to lower the gses’ capital surcharge from 30 percent to 20 percent in exchange for nothing more than vague promises from Mudd and Syron to raise “significant capital” at some point in the future.
• P252 – also on the effect of Barron’s article.  If the findings of
  those groups seemed familiar, it was because they aligned remarkably
  closely with the contentions made in the source document for the
  barron’s article sent to Treasury six months earlier–repeated,con-
  veniently, in another barron’s article appearing on August 16, which
  also contained an accurate description of the senior preferred stock
  agreement that would be imposed upon the companies the following
  month.
• P252 – one killing clause in law of GSEs: Tucked within the new law was a one-sentence clause that read “The members of the board of directors of a regulated entity shall not be liable to the shareholders or creditors of the regulated entity
  for acquiescing in or consenting in good faith to the appointment of the Agency as conservator or receiver for that regulated entity. This clause was not there by accident. It gave FHFA extremely broad latitude to put the company into conservatorship or receivership for virtually any reason. Fannie mae’s board and top executives-who represented the company’s shareholders–knew about the clause but had not objected to it because they naively believed the government
  would never use it unless absolutely necessary. They could not have been more wrong. Treasury had no intention of allowing Fannie Mae and Freddie Mac to operate as shareholder owned companies with the government standing behind their securities, particularly given their newly expanded market roles And it would be easier to poison the GSE’s shareholders now that their directors had been given an antodode.
• P268 – Tim Howard’s proposal on GSEs’ reform: The previous system failed not because of risk or a lack of effectiveness. but because of the consequences of unwavering opposition to Fannie mae’s and Freddie mac’s portfolio businesses. The GSEs portfolios always will be controversial, and for that reason I believe
  that in spite of the fact that they performed well throughout the mortgage crisis, they should be wound down over time, at a pace dictated by the ability of capital markets investors to absorb the loans they contain. Without their portfolios, Fannie Mae and Freddie mac could be given new charters as private companies, with regulated returns and limited to providing credit guarantees only on loans
  below a certain dollar amount and within defined credit parameters. They could be regulated either by the Fed or the Treasury, and their relationship to the government either could remain implicit or be made explicit through payment of a catastrophic risk reinsurance fee.
  A straightforward entity-based mortgage credit guaranty, with
  government backing, is the most effective and efficient way to channel fixed-rate mortgage funds to housing. It produces the lowest possible MBS yield required by capital markets investors, avoids the subjective judgments of credit rating agencies, and converts a pool of unrated individual mortgages to securities of the highest quality for a cost to home owners of only the amount of the guaranty fee(plus, for high loan-to-value-ratio mortgages, the cost of borrower-paid
  private mortgage insurance), which for my time at Fannie Mae aver
  aged around 20 basis points Whether the support is implicit or explicit, and whether or not a rechartered Fannie Mae and Freddie Mac are the mortgage guarantors, the government can offer credit support for residential mortgages at very little risk of loss. With prudent underwriting, professional management, national diversification, and competent regulation, residential mortgage lending is extremely safe.
• P274 – Good resources to study GSEs: In telling the Fannie Mae political story, I benefited greatly from access to a large set of articles from major newspapers and magazines that I began clipping and retaining shortly after the formation of
  the lobbying group FM Watch in 1999. Material from those articles proved invaluable in recreating the political dynamic that played out during the years of Frank raines’s chairmanship. Where there were gaps, contemporaneous articles from the Wall Street journal,Washington Past, New York Times, American Banker, and other sources generally were available through my online research.
• P275 – Good resource to study GSEs: A Short History of Financial Deregulation in the United States
• Dodson Edward’s summary and comments of this book (dodson-edward_review-of-mortgage-wars)