The following graph is derived from data in Fannie Mae’s (FNM) most recent monthly report. It compares the default rate experienced by Fannie on its book of conforming loans to the default rate on “enhanced” loans. The enhanced default rate is 4Xs higher than the regular default rate. Enhanced loans have performed very poorly over time.
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When a Fannie loan goes bust there are many economic losers including:
- The borrower will likely lose the property and suffer a variety of losses.
- The lender (Fannie) will lose money.
- The taxpayers pay for all of the losses at Fannie.
- The process of foreclosure causes RE comps to fall and results in devaluation of values in communities, towns, cities, states and ultimately the whole country.
- As RE values decline so does the tax base of municipalities. This adds pressure on state and local government's finances. The response is to cut expenses. Very often these cuts come from school budgets. Exactly the worst place for cuts to come from if a country was trying to stay competitive in a global world.
The collateral damage of defaults is much larger than the loss incurred by the lender. It cuts across society and the economy. Our country desperately needs policies that reduce the cycle of default. Until the default rates return to the historical mean there can be little hope of a sustained economic recovery. Our private financial institutions will continue to be suspect. The process of the FDIC closing banks every Friday will not stop. The public lenders, Fannie, Freddie (FRE) and FHA will continue to run up big losses. It will go on for years. The collateral damage will cripple towns, cities and states. As RE values decline, individual wealth will go down and with it will go consumption.
For me the most remarkable thing about this is that the Fin. Reg. proposals do not even mention the mortgage insurance (MI) industry. The proposed new rules take a shot at re-regulating the banks; they provide some protection to consumers from predatory lending, and sort of address concerns regarding derivatives. But they do not touch the MI providers. How could that be possible?
There are (at least) two reasons for the carve out of MI in the Fin. Reg.
- MICA, the industry spokesman and lobby was successful in keeping the MI companies out of the legislation. A job well done by MICA on behalf of its members.
- There is a belief in Washington that our RE market and therefore our economy cannot succeed unless credit is available for financing 95%+ of the cost of a home. FHA, the government owned PMI provider, continues to provide 96.5% LTV financing. They have admitted that they are suffering big losses as a result. FHA will be forced to reduce this activity. There is no stomach in D.C. for another bailout. Therefore there must be a private sector MI to take up the slack when FHA is forced to change its ways. As a result the private PMI providers were excluded from Fin. Reg.
Before the May meltdown, the PMI providers' stock prices were all on a tear. The future for the PMI providers may look bright to some. But the idea of creating high-risk mortgages that by definition have a high default rate makes no sense. The lobbyist, MICA, and their MI members are winners. Everyone else will be the loser. Fin.Reg. is a joke.
Who is one of the biggest players in the PMI market? AIG of course. We are protecting AIG. What in the world are we thinking of?