Mortgage Finance in the Aftermath of the Financial Crisis

10 Pages Posted: 14 Mar 2014

See all articles by William J. Dodwell

William J. Dodwell

Consultant to Financial Institutions

Date Written: August 31, 2013

Abstract

Mortgage finance lay at the very heart of the 2008 financial crisis as government forced banks to compromise lending standards to promote its affordable housing policy. This resulted in a proliferation of toxic subprime mortgages throughout the financial system. In the aftermath, banks dramatically curtailed lending and private-label mortgage securitization disappeared amidst an average 33% drop in home prices that created a sea of underwater mortgages.

In reaction to the crisis, the Federal Reserve Bank engaged in an ongoing series of quantitative easing involving the purchase of U.S. Treasuries and Agency mortgage-backed securities. This was aimed at maintaining low mortgage interest rates to support home sales and prices. The federal government took Fannie Mae and Freddie Mae into conservatorship infusing $187 billion of capital in the process. Congress passed the Dodd-Frank Act that set capital, leverage and liquidity requirements for banks. That legislation also established mortgage underwriting standards for lenders. Additionally, government sponsored a number of loan modification programs to help distressed borrowers.

Home prices have recovered about 20% from crisis lows while commercial real estate construction has resumed somewhat, especially apartment building. But new lending and private mortgage securitization depend on a much improved economy. Stricter mortgage underwriting will suppress lending until the economy recovers but will help to prevent another crisis, at least until government housing policy makes too many exceptions.

Fannie and Freddie have returned to profitability and returned 70% of the bailout funds amid a debate in Congress about its future purpose and structure. But investors are suing the government to allow the GSEs to retain profits, most of which are currently remitted to the Treasury according to a revised bailout agreement. A court victory would permit the newly profitable entities to resume servicing the heavily discounted publicly held preferred shares which would then appreciate to par. The government has warrants to purchase 80% of the common shares but future value will depend on the Supreme Court decision, government’s exercise of their warrants, whether the GSEs exit conservatorship and restructure, or whether the shares become worthless in liquidation.

Meanwhile, the FHA and HUD engage in continued moral hazard and wealth redistribution through risky lending to lower income borrowers out of President Obama’s zeal for social justice. Here we go again.

Keywords: relaxed lending standards, subprime mortgages, private-label mortgage securitization, home prices, Community Reinvestment Act, Dodd-Frank Act, Fannie and Freddie conservatorship, insolvent FHA, moral hazard

Suggested Citation

Dodwell, William J., Mortgage Finance in the Aftermath of the Financial Crisis (August 31, 2013). Available at SSRN: https://ssrn.com/abstract=2408181 or http://dx.doi.org/10.2139/ssrn.2408181

William J. Dodwell (Contact Author)

Consultant to Financial Institutions ( email )

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