Growing Risks to Housing Finance System?

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Happy Spring!

This issue of Capital Commentary highlights new potential risks to the housing finance system: reducing the effectiveness of transferring credit risk and eliminating title insurance and full appraisals on many loans.

Speaking of risks, we are also asking your opinion on whether bank regulators made the right decision to protect every deposit at Silicon Valley Bank, over and above the $250,000 guarantee by the Federal Deposit Insurance Corporation (FDIC).

Let’s dig in.

1. Big Thing: Costly Rulemaking Might Add to Borrower Woes

Interest rates, inflation and high home prices are combining to make homeownership increasingly expensive.

Now, the Securities and Exchange Commission (SEC) is contemplating a proposed rule that could make homeownership even costlier while adding more risk to the housing finance system.

The low-down: The SEC is proposing to carry out a rule pertaining to Section 27B of the Securities Act of 1933 that would prohibit conflicts of interest in asset-backed securitizations (ABS) transactions.

• It’s a well-intentioned rule required to be implemented after the 2010 passage of the Dodd-Frank Act. (Yes, nearly 13 years ago.)
• It is designed to prevent securitization participants (i.e., those parties that structure the deal) from benefiting from a loss on the transaction by betting against it — for instance, by short-selling the security or issuing credit default swaps against it.

Why it matters: But an overly broad interpretation of the rule could imperil most credit risk transfer (CRT) transactions by Fannie Mae, Freddie Mac and mortgage insurance companies, too. In short, the rule could limit the credit risk passed to well-diversified investors, increasing both their risks and capital costs.

• The GSEs transfer credit risk on 70% of the loans they purchase, mostly those with high loan-to-value ratios.
• Mortgage insurers use insurance-linked notes to pass along up to 90% of their credit risk. Mortgage insurance enables borrowers to purchase a home with less than 20% down.

The big picture: Why would CRT transactions fall under the proposed conflict of interest rule?

It’s complicated, but in a nutshell:

• CRT investors receive premiums for accepting the risk of mortgage defaults.

• In return for the premiums, investors promise to compensate the GSEs or mortgage insurers once losses reach a certain threshold, called the attachment point.
• Mortgage industry experts fear the SEC could determine that the GSE or mortgage insurer will benefit from the adverse performance of the covered mortgages once losses exceed the threshold, which could be construed as a conflict of interest.

The bottom line: If they can’t transfer credit risk in the capital markets, borrowers will likely face higher mortgage-related costs in the form of higher interest rates and/or steeper MI premiums.

What’s next: The SEC is accepting letters on the proposed rule until March 27. Mortgage insurance interests will seek clarity that ordinary CRT should not be considered a conflict of interest because CRT mitigates systemic risk in the housing finance system.

• Don’t expect a quick resolution: The SEC may take another year to work through all the comments and associated analysis to finalize the rule.

2. Title Insurance, Appraisals on the Way Out?

Fannie Mae is making good on its promise to try to reduce home loan closing costs while making waves among settlement-service providers.

Why it matters: Fannie issued a 2021 report, “Barriers to Entry: Closing Costs for First-Time and Low-Income Homebuyers,” citing appraisals and title insurance as two particularly burdensome fees for those borrowers.

• Fannie is putting a bull’s-eye on those two expenses to make homeownership more affordable and sustainable.

“Services in the mortgage process such as lender title insurance, appraisals, and credit reports help lenders and investors measure, manage, and price the risks inherent in mortgage lending. … But in the main, borrowers bear the cost of this benefit, and … that cost is regressive: First-time and low-income homebuyers pay more on a relative basis than existing or higher-income homeowners.”

 — Fannie Mae’s Barriers to Entry study

First steps: This month, Fannie announced that appraisals are no longer the default requirement for establishing market value. Instead, it is introducing a range of options:

• “Value acceptance,” essentially an appraisal waiver.
• “Value acceptance + property value” uses property data from a third party that conducts interior and exterior data collection on the subject property. The lender must verify that the data collectors are knowledgeable, professionally trained and vetted.
• “Hybrid appraisals,” in which property data is provided to an appraiser to inform the appraisal.

What’s next: Fannie is reportedly looking at a pilot that would provide some lenders a waiver on title insurance. The news was broken by a POLITICO Pro newsletter.

What they’re saying: Representatives of the two industries expressed their outrage.

Appraiser Dave Towne of Towne Appraisals complained that Fannie is trying to put appraisers out of business.

“Why should ‘we’ continue providing appraisal service to an organization which basically has a vendetta to shove us aside, and do away with appraisers?” he asks on AppraisersBlogs.

The American Land Title Association (ALTA), the trade group for the title insurance industry, called on the Federal Housing Finance Agency to halt Fannie Mae’s reported entry into the title business.

“It appears Fannie Mae is moving beyond its charter and mission directly into the title insurance business. … If the 2008 financial crisis taught us anything, it is that shortcuts to well-established processes pose great risks to our sound, dependable, and trustworthy real estate system.”

— ALTA statement in an email to Housing Wire.

3. Now It’s Your Turn: Smart or Not?

In mid-March, the FDIC, Federal Reserve and U.S. Department of the Treasury agreed to make whole all depositors of the failed Silicon Valley Bank, overriding the $250,000 cap provided by FDIC insurance.

• The decision was reportedly made to contain potential systemic risk in the banking industry.

The choice split economists and politicians, but not necessarily along party lines.

• Liberal Sen. Bernie Sanders, Ind-Vermont, and conservative Rep. Marjorie Taylor Green, R-Georgia, both opposed the decision.
• Sen. Mitt Romney, R-Utah, and President Joe Biden endorsed the choice.

What do you think?

Should bank regulators have held the line on FDIC insurance coverage or guaranteed every deposit?