PolicyCast: Housing’s Big Picture

Kirk Willison, Arch MI’s Vice President for Government and Industry Relations:

To anyone who has spent even a little time in the housing industry, my first guest of the 2023 Arch Mortgage Insurance PolicyCast season probably needs no introduction. Over the course of his career, David Stevens originated home loans and headed sales divisions for primary and secondary housing giants, Wells Fargo and Freddie Mac. He served as president of one of the nation’s largest real estate companies and chief executive of the Mortgage Bankers Association. Now, CEO of his own consulting firm, Mountain Lake Consulting, Stevens’ experience puts him in rare company as a policy advisor to presidents of housing finance companies and the President of the United States. He was formerly Assistant Secretary for Housing and Federal Housing Commissioner. If you want the big picture for housing policy in trends in 2023, who better to ask than Dave Stevens?

Well, Dave Stevens, thank you very much for being here for the first episode of the Arch Mortgage Insurance PolicyCast for 2023. We’re calling this first episode the Big Picture and think that you’re the perfect candidate to come and chat with us about that. We’re really looking forward to your perspectives.

Dave Stevens, CEO, Mountain Lake Consulting:

Good to be with you Kirk, as always.

Willison:

Dave, we’ve seen really tremendous peaks and valleys for the mortgage industry for the past 12 months or so, and you’ve done a lot of writing on that topic, on a number of different forums. What do you think we ought to expect in 2023?

Stevens:

I think we’re on the precipice of seeing the end of the worst of the housing market in terms of what we’ve just been through starting late last year. And definitely this quarter isn’t a lot better, but it is certainly better. As you know, we all saw loan application activity jumped over 20% last week. And clearly interest rates have started to come down. We will be entering the early phase of the spring market. We still have an extraordinary shortage of inventory, and the nation is facing the biggest wave of demographic demand that we’ve seen generationally since the baby boomers started buying homes in their early years, in the 1980s. So what’s causing all of us pain and has caused us pain in the last several months is that 2.5% is no longer here.

Refinances went away. That caused an extraordinary contraction in the marketplace. But I think in general terms, the market’s right-sizing. We’ve had some mergers. Some companies have shut their doors; other companies have shed excess labor. I think margins are coming back into the business. Interest rates are coming down off of their peak of 7% clearly around 6% today, and probably heading into the 5s here shortly. And so once [Jerome] Powell [Chair of the U.S. Federal Reserve] is done (which most expect, due to inflation data that they’re seeing right now, that he is almost done), then we’re going to see once that is signaled that the rise of the Fed funds rate has come to an end. Just watch. I just say, hold on. The stock market will have a surge. Interest rates will continue to rally, not to where they were before, but clearly the mid-to-low 5s is absolutely within range. And then the demographics of demand are going to take over. And I think by the end of the year, we’ll be back into the same problems in the purchase market that we felt a year ago, which is supply shortages, full price offers and more of a seller’s market.

Willison:

You recently tried to calm the waters in an article when you talked about home prices always going up. Can you talk a little bit about that?

Stevens:

If you follow me on LinkedIn, I’ve been doing a series of articles that I publish in a newsletter for LinkedIn talking about perspective. And one perspective is a good one. You can pull it off of the Federal Reserve of St. Louis site, Federal Reserve Economic Data (FRED). Hopefully everybody’s who’s watching this has been there before, but it’s a great resource for data. And if you go to FRED and you just look at the median home prices (median price of homes sold in the U.S.), they have a chart that’ll take you back to 1955, which is, you know, I wasn’t even born then, right? I was born in ‘57, so, I’m an old-timer in this business. So it takes you back to 1955, and it tracks home prices from ‘55 to the most recent data point, which is just three months ago.

So the point being, through 10 recessions since 1955, 10 of them, some bigger, some less big, including the great recession of ’08, while home prices may dip for a moment, home prices have always gone up. And the median value of homes in America has always risen. And I use that to make an argument that personally, I think if you’re sitting on the sidelines waiting for something to happen (I hear people say, I’m going to wait for homes to right-size or home values to right-size), personally I really think that is a mistake. I encourage my kids, my best friends, to buy homes. I think that window of opportunity is now because once [Jerome] Powell [Chair of the U.S. Federal Reserve] signals that we’re done with quantitative tightening and the market begins to regain its enthusiasm, which will be the second half of this year. And in the next couple of years, which will be pretty strong, I think it all switches back and reverts back to them.

Willison:

So I guess we shouldn’t be surprised you’re a long-term optimist for the industry, but in the immediate term the industry does have some real challenges. You just mentioned a couple minutes ago, there’s been a lot of layoffs. Lenders have either shut down operations or exited certain lines of businesses. What advice would you give mortgage lending executives as they grapple with a smaller market in the near term, but prepare for the future as well?

Stevens:

Yeah, it’s actually a lot. I have several clients who are sizable non-bank lenders, and I’ve watched them, what they did over the fall and pre-holiday. I think most of us in the business know that there was a lot of layoff[s] that occurred across the industry pre-holiday. I think even the best independent mortgage banker executives have to realize, looking back at their last decade and a half, how big they became, how large and fast those companies grew, and  that it’s not sustainable. This is a zero-sum game. You certainly can try to buy market share, but in my view, you only rent it. You never actually own it because you can’t subsidize pricing forever. So in the end of the day, I think it comes down to a couple things.

One is extraordinary discipline, an operational support for the sales force. You know we created a lot of excess head count to support these branches and teams that we acquired in the past several years and let them bring their entire teams in, and that just can’t be supported in the contracting market. So that, I think, there has to be continued discipline on making cuts or consolidating support teams to cover broader geographic areas than they currently do. And that’ll improve effectiveness and efficiencies. And then, on the sales side, the one thing I’ve argued for years, and I argue more so now with my clients, is that not everybody’s built for a purchase market. I mean, a refinance market is business-to-consumer. You’re selling directly to a homeowner. And in most cases you’re saying, hey, I can take your 4 [% rate] and turn it into a 3.

It’s a very easy shooting-ducks-in-a-barrel kind of sales environment when you’re in a refi boom like we were in 2020 and ‘21. And it makes people feel like they’re better than they are. And it makes companies look better than they would normally be across the board. Converting to a purchase market is a very proactive selling skill. You have to be able to actually go out, build relationships, get rejected. The sales cycle’s longer because that Realtor® or homebuilder you’re making a relationship with. Today, they may not even have a transaction this week, this month. It may be a while before you can actually get a referral from them. You have to be much more disciplined in your sales style, your sales approach, your techniques and capabilities.

Willison:

Let’s talk a little bit about market segmentation. This past October, the Federal Housing Finance Agency [FHFA] ordered the GSEs, Fannie Mae and Freddie Mac, to eliminate their loan-level price adjustments on most of the affordable loans that they purchase. And then in January, the Agencies refined their pricing a little bit more to reduce prices for loans with lower FICOs® and higher LTVs. Do you think that was the right move? And what exactly is FHFA trying to do?

Stevens:

Kirk, you and I both know all too well because we worked together at Freddie Mac. We lived this life and the challenge of doing affordable lending out of a risk-based pricing structure that the GSEs offered. The advantage the FHA has always had in the affordable lending space is that it’s a cross-subsidy program. In other words, the better credit subsidized the worse credits, and everybody gets the same price. Quickly, anything below 720 FICO at 95 [%] LTV or above has better execution by FHA for a homebuyer. And it’s frustrated the regulators. It’s frustrated consumer advocates who don’t want FHA to be the sole provider of affordable lending programs. But nevertheless, two-thirds of all African Americans have gotten their mortgage from the FHA, pretty consistently for the past several years.

So Sandra [Thompson, Director of the Federal Housing Finance Agency] has I think probably forced the GSEs. I’m guessing it was more of a kicking and screaming kind of effort. We never saw the blood on the floor. But having been there, Kirk, and you know what it’s like to argue with some of the capital markets and credit guys to subsidize what are likely going to be higher incidents of default mortgages, meaning those high-LTV, lower-FICO buckets, and there were pretty significant changes if you look at the new LLPA [Loan-Level Price Adjustment] grid. That’s a painful thing for a culture like Fannie and Freddie — how they’ve operated over the last many decades. Is it the right thing to do? I think Fannie and Freddie have been horrendous at providing true affordable lending. And we did a lot of jockeying back over the years to try to get more affordable lending.

But you know how we did that? We would buy already-wrapped loans, and we’d just rewrap them. We’d buy Fannies and wrap them in a Freddie, and we’d pay up for particular census tracts, lower loan balances and certain other attributes that would help us hit our affordable housing goals. But it was really very much a shell game. And so I think what Sandra [Thompson, Director of the Federal Housing Finance Agency] is doing is saying, That’s no longer going to work. You are essentially arms of the Federal government. People could argue that, but that’s essentially the case in conservatorship. And we have you now have an explicit mission obligation. And the only way — one of the big hurdles here is certainly price. And if you can’t be competitive with FHA in those high-LTV, lower-FICO buckets, you’re just never going to solve that paradox. And so, I think, there’s no question she plans on doing it, she plans on cross- subsidizing that with increased fees on things like second homes and two-to-fours. I’m going to give you my answer: I applaud the move. I think it’s needed and long overdue.

Willison:

Kind of part and parcel of this, FHFA has required Fannie and Freddie to create equitable housing finance plans. And I guess this will be part of it. So a combination of a question here: What do you think the role of the GSEs is in expanding affordable homeownership? And, secondly, how can mortgage lenders themselves do a better job of connecting to underserved markets to really make homeownership more equitable across the board?

Stevens:

In terms of the affordable lending space, I think Fannie and Freddie have not had the obligations thrust upon them that they otherwise should have had over the years to come. And, you know, I [hark] back to the days of Craig Nickerson [From 1997 to 2008, Craig was VP of Expanding Markets for Freddie Mac] when he was the spirit behind affordable lending at Freddie Mac, always trying to fight the uphill battle to get the company more engaged in that area. And, I thought, my own view is the GSEs did just enough to check the box to meet whatever that affordable housing goal is in the past. It should be an obligation on Freddie Mac and Fannie Mae and much more explicit without any wiggle room to kind of fudge the numbers by doing fancy secondary market executions that don’t really expand the box.

As it comes to lenders, there are two approaches here, right? You have banks like Bank of America and Wells Fargo, which are now creating specific programs that they’re subsidizing clearly that likely will be held in portfolio. Maybe they can be sold into Agency pools or other sorts of specified pools as private label securities. But, nevertheless, their bank portfolios are subsidizing the product. And, I think, because they have greater incentive to. They’re banks. They have CRA [Community Reinvestment Act] obligations, and they have more of a target on their back from a policymaking standpoint on Capitol Hill. But other non-banks can also play a role here.

I do believe that there’s a mission that all lenders should have, particularly the larger independent mortgage bankers, some of whom have gone public. And I think the way you do that is you begin to create and recruit and market to underserved communities. And to do that, you need to be hiring people who can work and operate in those markets. And my sense is, as you well know, Kirk, we have a lot of states and federal agencies looking at alternatives that are CRA-like that would actually force the IMB [independent mortgage banks] to do more in this space. And my own sense of this is that’s probably going to happen at some point. And it’s a great opportunity to get ahead of the game here and start doing some investing in the markets that you serve.

Willison:

One of the areas that FHFA and certainly a lot of consumer advocates have been talking about are credit scores. And we’ve seen a recent change requiring lenders sometime in the future to report credit scores from both FICO and VantageScore®. And I was wondering from your perspective what’s the likely impact that this change will have on not only borrowers, but lenders, servicers, investors, mortgage insurers?

Stevens:

Yeah, it was a highly debated policy. I was one who advocated for years to bring VantageScore into the GSEs, and I met with [former FHFA Directors Edward] DeMarco [served 2009–2014] and Mel Watt [served 2014–2019], and many of us did. A lot of other financial institutions didn’t want multiple FICOs. They were worried about score shopping and adverse selection. And how would you do it? We talked about how you’d have to pick one score and that’s [the] only score you could use for 90 days or six months or a year, whatever that period of time is. So you couldn’t adversely select the GSEs, because the last thing you want is a bunch of lenders going out there and picking the score that gives them their “yes” answer. There’s been a lot of natural resistance, whether it’s adverse selection or operational cost vs. the lift, but there is no question in my mind that if we looked at models and looked at VantageScore that they could score tens of thousands more Americans with a credit score that today would not get that score through the current offerings in the credit system.

And we would have these arguments with the regulators back in the day when I was still at the NBA [National Bankers Association] and before, and they would say, “yeah, I know, it’s 10,000 or 20,000 more Americans, but of that percentage, how many are actually going to be able to buy a home and blah, blah, blah.” They’d narrow it down to the point where they’d say, “it’s just not worth the effort.” And again, that’s just another failure, I think, of the system of Fannie and Freddie and the lack of push by previous regulators. Again, this is another move by Sandra Thompson. I think she’s proven herself to be very effective as the Director of FHFA. If you view the various moves they’ve done, they’ve tried to expand access to mortgage products offered by Fannie Mae and Freddie Mac through the LLPA adjustments or using other scores as positive for bringing more homebuyers. And keep in mind, Kirk, as you all know, they have yet to really show us exactly how they’re going to do it, and we’re waiting to see what the implementation of that will look like. But my sense is that what they’ll probably do at a minimum is start collecting VantageScore, which is what I’ve always advocated for, and be able to evaluate credit performance along with both the FICO and Avanti score on the file. But we’ll see how they ultimately implement this.

Willison:

Let’s take a look at another issue that you’re certainly very familiar with from your history. FHA’s capital levels now exceed 11%, far above the 2% statutory rate. If you were sitting in the FHA’s Commissioner’s office today, would you be pushing for a premium cut?

Stevens:

Yes, no question. And I know this isn’t thrilling to mortgage insurance companies, but in the end of the day the amount of capital that FHA has and the pricing level that they’re at is completely unwarranted. FHA is not meant to be a profit center for other Federal programs. Here’s my bet, guys: I would not be blaming Julia Gordon [Assistant Secretary for Housing and Federal Housing Commissioner at the U.S. Department of Housing and Urban Development] per se on this one. My sense is that there’s a battle going on between Julia and OMB [U.S. Office of Management and Budget], and OMB, putting together a budget, particularly one where there’s such focus on spending, will need every penny they can get. Back when I was running FHA on the premium, I used to have to fight these battles on the premium, but the good news on my side was that I was basically raising premiums then because they were much lower.

And as you know, the MMI [Mutual Mortgage Insurance] Fund was in a terrible situation. So I actually got legislation passed to help to change the premium structure. I put in that life-of-loan premium, sorry guys. But in the end of the day, we’re at a point right now where the premiums do not reflect the credit quality of the portfolio. They’ve fixed a lot of the problems. They no longer have seller-funded down-payment- assistance loans to worry about. The quality of credit and the rest of the portfolio, particularly with home equity that’s grown so dramatically in this country, makes that portfolio extraordinarily strong. I think it’s almost criminal, if you think about housing policy, that they haven’t lowered premiums, because 80% of purchase transactions at FHA are the first-time homebuyers. Two-thirds, as I told you earlier, of African Americans, and roughly the same for Latinos, get their purchase transactions through an FHA, VA or USDA programs. It’s significant. Every day they don’t lower the premium, they’re overcharging the consumer.

Willison:

Dave, you’ve been a great guest. Thanks very much for helping us kick off the policy cast for 2023.

Stevens:

Thanks, Kirk.