Fannie Mae to Rent Foreclosed Homes

Fannie Mae to Rent Foreclosed Homes Back to Borrowers

Fannie Mae plans to allow homeowners facing foreclosure to stay in their homes and rent them for up to one year as part of the latest effort to help troubled borrowers while keeping a glut of foreclosed properties from hitting the housing market.

The slippery slope continues. The original scope of Fannie and Freddie (let’s call them GSE for Government Sponsored Enterprises) was to create uniform mortgages and to securitize them for sale to investors. For those not familiar with the process, it was supposed to work like this.

A bank originates a loan using GSE guidelines. The loan is then sold by the bank to the GSE.  The GSE then pools the mortgages together into a “mortgaged back security.” Sometimes referred to as RMBS (Residential Mortgage Backed Security).  For example, you might have 100 mortgages pooled into a security called “Fannie Mortgage Series 2009-A.” The next step in the process was for the GSE to sell the RMBS security it created to a third party.

During the housing boom, these RMBS securities performed well and the GSEs decided that they would actually hold the RMBS on their own books instead of selling it off to third parties. This was in part responsible for the great earnings by the GSEs in the 2004-2005.

For the time being, it was more profit for the GSEs and Congress loved it because it created more liquidity for the housing market. The problem was that there was already too much money chasing RMBS. So even if the GSEs didn’t hold the RMBS on their own books, there would have been a problem. But now that the GSEs were holding the RMBS on their own books there was even more excess liquidity.

This all translated into loans being made to borrowers that were not creditworthy. There was too much free government money and not enough creditworthy borrowers.  So now you have a situation whereby the government isn’t just involved in packaging the mortgages, but the government is actually owning a huge percentage of the mortgages in this country (I’ve heard that the GSEs own as much as 50% of the RMBS – that is hearsay so don’t quote me on that). So instead of requiring private capital to fund mortgages, the government printing press was available. The normal market based limitations that would limit the capital available for mortgages became unlimited.

Well, today the government and the GSEs slide further down the slippery slope. The GSEs have gone from effectively being a broker for RMBS, to owning mortgages to now owning and operating real estate.

Now the interesting part. Ordinary banks are typically prohibited from owning and operating real estate. The banks are permitted to foreclose and hold the property with their REO group (Real Estate Owned). However, the banks need to unload the properties within a certain period of time and actively market the property for sale. This is because banks are in the business of lending money and not in the business of owning owning and operating real estate.

The public policy against banks owning real estate is that it is too risky for a regulated institution. Part of what Gramm-Leach-Bliley Act did in 1999 was repeal a portion of the Glass-Steagall Act. In short, repealing Glass-Steagall allowed big banks like Citigroup to form a bank holding company and own real estate and other non-banking operations in separate operating entities walled off from the conventional banking business.

Whether you agree with Gramm-Leach Bliley or not (save that for another day), at least the regulation put a wall and controls between the regulated bank and the other businesses owned by the bank holding company (although Citigroup is the poster child for why this change to Glass-Steagall was a bad idea).

So here is the rub.  Now the GSEs can do what other lenders cannot even do under Gramm-Leach Bliley. The GSEs have gone from brokers, to owning mortgages (which should not have been permitted), to owning and operating real estate.

So what is my prediction?

The banks scream over this change. After all, it is “unfair competition” that the GSEs can now own and operate real estate while the banks are forced to sell off their REO at fire sale prices. So how does it end?

Look for new regulation temporarily permitting the regular banks to own and operate real estate to put them on a level playing field with the GSEs. Ultimately, instead of bringing the banking system back to the way it was under Glass-Steagall and prohibiting banks from participating in non-banking business, I think there is a good chance that we’ll go completely the other way and effectively permit banks to own and operate their real estate portfolios on a long term basis.

Note that this post is only related to RMBS and doesn’t cover Commercial Mortgage Backed Securities (CMBS). Don’t be surprised to see that wrapped in as well. I can envision “lenders helping small business stay in their single tenant office building by deeding it back to the lender and leasing it back.”

Really, the possibilities are endless once the banks can get into the business of owning and operating real estate.

I can already picture the accounting shenanigans. For example, the owner deeds the property back to the bank in lieu of foreclosure and takes a lease back from the GSE (or bank). The asset now gets appraised at a “leased up value” instead of as a vacant foreclosure property which is likely in distress. 

Of course, many states have “redemption statutes” permitting an owner (whether it is by traditional foreclosure or this “deed in lieu”) to get their property back within a certain period of time by paying off the debt even after the property is deeded back to the lender. So the owner gets to stay in the house and in many cases will still have an option to get the property back for the amount of the debt if it goes back up in value before the redemption period ends (or if the owner can find another lender to refinance the property).

So in the end, we’re likely talking about more risk being introduced into the banking system and more creative accounting.

Wait and see. You heard it here first. I can smell another bank rally.