The Outlook for Financial Reform

In the wake of the worst financial disaster in 75 years, there has been a call for additional regulation of financial institutions. In response to these demands, the Obama administration just unveiled an 88-page book that outlines its proposals for overhauling the financial regulatory system. I have not read it yet, but I understand that key among the provisions of this document is increased authority for the Federal Reserve System and the abolition of just one agency, the Office of Thrift Supervision. 

The cry for more regulation is quite understandable as most everyone in America is undergoing financial and emotional stress due to job loss, declining housing values and, severe cuts in values investments (including pension plans), and the other after-effects of the sub-prime bomb.

What I find incredible is that we are jumping ahead in this process. Rather than issue new regulations, what we really need to do is to take a long and very hard look at exactly how the various regulatory agencies were supposed to work and how they failed. We ought to know why the patient got sick before we recommend the cure. Knowing how institutions failed in spite of oversight will allow formation of a much better regimen for the future.

Here's my take. With one notable exception -- the FDIC -- financial regulators seem to be incredibly ineffective. They publish annual reports that justify their existence, but when it comes to trying to measure their results, much is left to be desired. When a crisis occurs, they always say, "We can’t do our job because we don’t have enough power. We want more laws, more employees, and bigger budgets."

Let's take an example: the Federal housing Finance Agency. This agency is successor in name to the Office of Federal Housing Enterprise Oversight. This agency has had responsibility for overseeing Fannie Mae and Freddie Mac since 1992. During this period, both companies expanded dramatically.

This expansion was due in large part to fact that their biggest competitor in the mortgage field, the Savings & Loan industry, was being dismembered by the hastily created Resolution Trust Corporation in the in the late 1980s and early 1990s. (That debacle was due in part to another gross regulatory failure by the Office of Thrift Supervision, a story for another day.)        

It wasn't like the problems at Fannie and Freddie weren't obvious. There were accounting scandals as well as misstatements of earnings that seem to have been designed to assure that the top management got egregious bonuses. I think that the same stories would pop up if you looked at the inner workings of all the other financial regulators from the Fed to the SEC to the FTC and a myriad of other agencies.

The bottom line is that Congress will NEVER be able to come up with enough rules and enough regulators to supervise the mortgage industry that funds something like 40,000 transactions every day.  It's just not going to happen.

I know this judgment flies in the face of logic to those people who believe that someone riding in on a U.S. Government white horse can fix these things. In spite of the tens of thousands of pages of laws, government has demonstrated no ability to do it in the 30 years that I have been in the business. Another 50,000 pages of laws and another 50,000 bureaucrats isn't going to fix it in the next 30 years either. 

The way to fix this problem is to educate the 10 million people who get loans every year. If you make them smart enough, the shysters out there will not be able to take advantage of them. The tools are there and I think that there is willingness on the part of consumers. You just have to meet them more than half way.  That's a topic for another day.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles, Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.

Stimulating Homebuying

Would increasing the first-time homebuyer credit to $15,000 stimulate homebuying?

The current stimulus package provides an $8,000 first-time homebuyer tax credit. And proposed legislation could increase that credit to $15,000. For the most part, the features of this credit seem to carry over to the newly proposed program with a few additional ones, like not having income restrictions.

Before we get started, it's important to understand that the existing credit is unlike the $7,500 credit that was passed a year ago. That program was really an interest-free loan because the $7,500 had to be paid back. The $8,000 credit does not have to be repaid and neither will the $15,000 credit, should the bill pass.

Most potential first-time homebuyers prepare themselves by saving money for a down payment. They check their credit scores and peruse their credit reports for errors. And I hope they have been getting an education.

After that, buying a home is a marginal game. By that I mean that homebuyers look at marginal differences in the details. For example, if property values come down, a once unaffordable home may become affordable. If interest rates come down a little bit it, the monthly payment will be a little bit lower.

Adding an $8,000 tax credit to the equation changes that equation too. Whatever the economies were before, they are now $8,000 better. Every time values drop, rates drop, or something like this tax credit comes along, a number of homebuyers are better positioned to buy a home. Every marginal improvement helps someone out and makes it more likely that they will buy a home.

This position comes from an academic analysis that may not bear any relation to the real world. But we do have real experience with testing this model. In this decade, Wall Street and the subprime mortgage industry said, "To heck with all these silly rules. We will do a loan for anybody!" That action took a lot of people off the sidelines and into the housing market. Perhaps a million of these homeowners have lost their homes due to foreclosure – so this wasn't a good idea.

That extra demand helped fuel the hyperinflation in housing values that created the bubble that popped and caused our current economic woes. We don't want that again. And with mortgage rules as tight as they are today, we are unlikely to have a recurrence. Rules are pretty tight today.

So the question remains whether an additional tax credit is a motivating factor. I must say that I don't see people saying, "With an $8,000 credit, I wasn't interested, but now that it's $15,000 I am really interested in buying a home." I may be wrong. You would have to go interview 1,000 homebuyers and ask them to what extent the tax credit was a motivating factor. I'd like to know what the results of such a survey would be; I wish someone would do that survey.

Let's step back and look at the economics of a purchase transaction. Let's say a couple was interested in a $300,000 home a while ago. They were going to put $60,000 (20 percent) down and get a $240,000 loan at 6 percent. Now they can buy the home for $250,000 and with their $60,000 down payment they need a $190,000 loan – and the rate is now 5 percent:

                               Old  Deal               New Deal 
Sales price             300,000                  250,000
Loan                        240,000                  190,000
Rate                             6%                          5%

Payment                  1,899                      1,320  
Income to qualify     57,000                   40,000

As you can see, market forces have dramatically altered the landscape here. For this particular home in this market, a lot more people can qualify.  Does a tax credit make it more appealing? Sure it does. Would someone buy this home in these circumstances without the credit? Maybe; maybe not. There are other forces at work.

So we are back to the starting point, the possibility of increasing the tax credit to $15,000. Would that help revive the housing market? It’s hard to say. Again, this is a marginal benefit environment and increasing the benefits would, at least academically, attract more buyers.

In normal times, there are about 1 million homes built every year, although that number will be only 500,000 this year. Right now we don’t need new homes because of the homes that were or will be vacated by foreclosures.

Let's say that 1,500,000 potential homebuying households are created each year. At a cost of $8,000 per home, it costs the government (read: you and me as taxpayers) $12 billion dollars in tax credits if they leave the current program in place. If you increase the credit, you don't have to pay it just to the newest people. You have to pay it to everyone, including the people who were happy with the $8,000 credit and those who don't need the credit at all.

The only reason for doing this is to stimulate EVEN MORE people to buy a home. If we increase the tax credit to $15,000 and assume that adds another 100,000 new homebuyers, then we now have 1,600,000 homes receiving a $15,000 credit at a total cost of $24 billion – double the cost to the government (again, you and me as the taxpayers).

But if you only attract 100,000 more homebuyers but have to pay all 1,600,000 of them, in effect you will have paid $120,000 per marginal household to encourage those 100,000 people to buy a home. That's mathematically equivalent to giving 100,000 people a $120,000 home for free. Isn't there a better way?

For example, when we distribute welfare funds, the money goes only to those who need it. They don't give money to everyone. Why shouldn’t it be the same here? If this is a "marginal game," as I have suggested, why not use stimulus money to attract only those people for whom this credit is the difference between buying and not buying?

I know: The way Washington is throwing money around these days, what's another $12 billion?  But I really question if increasing the tax credit to $15,000 is the wisest way to do this. There are certainly a number of vehicles, like down payment assistance – that would have to be paid only to deserving households – that would be more cost effective.  

Homebuyers who might benefit from this tax credit should see IRS form 5405.

If you are a potential homebuyer, I would jump on the current tax credit opportunity. If the new law were to pass, you'd probably get that additional benefit too. And at that point it would be icing on the cake.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles, Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.

Options Are Still Open to Refinance

With the jump in mortgage rates last week, there are certainly millions of people who feel that they missed the boat. The question is, "Are there still refinance options that make sense?"

Not if you had a 6 percent fixed rate loan and wanted to refinance into a new one at 4.75 percent. That opportunity does not exist today, although there is still some likelihood that rates will drop, maybe not to 4.5 percent but maybe to 5 percent. At that point you have another opportunity. The important thing is to prepare so that if and when that happens you will be ready.

But there are other reasons as well. For example, there are millions of homeowners who have adjustable rate mortgages that are currently very low because the short-term rate index they are tied to is low. As we speak, the 6-month LIBOR rate that many ARM loans are tied to is a mere 1.23 percent. Add a typical margin of 2.5 and you have a current note rate 3.75 percent. Nothing wrong with that -- at least for now.

But if you recall, the 6-month LIBOR index was around 5 percent for almost all of 2006 and 2007. You can research these rates and compare them with today's numbers. That means that your mortgage rate would have been 7.5 percent. So if and when LIBOR rates go to 5 percent again, as is likely, your mortgage will be at 7.5 percent.  Do I hear you gasp? Therefore, a good strategy would be for you to trade that loan in for a fixed rate loan.

The same thing applies to people who have 5-, 7- and 10-year hybrid adjustable loans that are still in the fixed rate period. Okay, so you are at 4-something percent or 5-something percent now.  What happens when when it switches to an ARM and makes its first adjustment? Maybe you will be at 7.5 percent too. 

If you don't want that to happen, you ought to do something about it now, while you can.

And then there are people who have large balances on their HELOC loans. Those loans are tied to prime rate and are likely in the 4 percent range now. That is attractive... now. But remember in mid-2006 when prime rate was 8.25 percent? If you didn't remember, take a quick refresher course by checking out the history of the prime rate.

The point is that all of these people are open to significant rate risk -- risk that CAN BE avoided, but only if they take action. Action means getting off of the adjustable rate roller coaster and getting a fixed rate loan. Okay, maybe not at 4.5 percent, but anything in the 5 percent range is just great from a historical perspective.

There are still tens millions of homeowners out there who are paying more than 6 percent, so do not whine if you have to pay 5.75 percent for your loan.

Finally, 15-year fixed rate loans are still cheap, under 5 percent today. So if you are a few years into a 30-year loan in the mid-6 percent and are trying to figure out what to do, it's time to consider that alternative. You might find out that the payment actually goes down and that you can save tens of thousands of dollars in interest. There are good calculators available to help you calculate just how much you can save.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles, Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.

The Outlook for Fannie Mae and Freddie Mac

Federal Housing Finance Agency chief James Lockhart’s testimony before the House Financial Services Committee deserves analysis. Ever since the federal government took over Fannie and Freddie, the FHFA has acted as the conservator of the two enterprises.

Bottom line: Fannie and Freddie continue to roll up losses, as previously reported. But the good news is that the government is ready to keep supporting them. The Federal Reserve Board and the Treasury Department have already bought $804 billion in mortgage-backed securities from them.

I do not see how that could be allowed to change. To put it bluntly, economic recovery depends on restoring the housing market. Home equity has always been a significant ingredient, if not the greatest component, of a family's personal wealth. Eroding values have left some 10 million families with no equity in their homes. A couple of million more families have lost their homes to foreclosure.

Therefore, as I see it, recovery depends upon the continued operation and health of Fannie and Freddie, which account for more than 70 percent of the mortgage market today. FHA probably accounts for another 20 percent with the small remaining fraction composed of what remains of the "pure capitalist component" of the mortgage market.

We are starting also to get some idea of what went wrong in these markets. Here’s a quick summary here: In 2002, we started the first refinance boom of the decade. Mortgage originations swelled as rates dropped. Rates were in the 6 percent range and that allowed millions of homeowners with 7- 9 percent rates to refinance. In 2003 and into 2004, rates fell into the 5 percent range, further stimulating the boom.

But in 2005 the boom was beginning to subside. And it was at this point that the subprime industry that had been building on the sidelines took center stage. Subprime originations mushroomed as the industry started doing loans for borrowers with impaired credit and no down payment, or both.

It now appears that Fannie and Freddie started looking at "market share." Now I understand Proctor & Gamble being vitally concerned about the market share of Tide, but it seems wholly out of place for Fannie and Freddie to do so. I suppose they recognized that there was a market segment in which they were not participants.

Helllloooo! That was never what they were supposed to be doing! But in an effort to maintain volume after the drop in volume from the prior few years, they jumped into the market. As the FHFA report says:

"Ultimately, the Enterprises eroded their own credit standards in an effort to keep pace with the rapid growth of subprime and other non-traditional mortgages funded with PLS," (private label securities issued by subprime lenders).

As a loan originator myself, it was never apparent in our market that Fannie and Freddie would do subprime loans. But they certainly did allow "piggyback loans" where borrowers did not make down payments. The borrower would get an 80 percent 1st loan from Fannie or Freddie and get a 20 percent 2nd loan, the piggyback loan. But at least those were to creditworthy borrowers.

Finally, I will take Mr. Lockhart to task. He stated:

"The enhanced regulatory authorities provided by that legislation [the Housing and Economic Recovery Act of 2008] came too late to allow FHFA to prevent excessive leveraging and to address serious safety and soundness issues at Fannie Mae and Freddie Mac."

Mr. Lockhart seems to be acting like he just came on the scene. He overlooks the fact that the FHFA is nothing more than a new name for the Office of Federal Housing Enterprise Oversight that was responsible for supervising Fannie and Freddie since 1992. Obviously, he and they failed in that regulatory mission and must bear some responsibility for the current mess.

Read the full 23-page report of his testimony.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles, Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.

DEEEECLINED! Get the Details about Your Notice of Denial!

Doritos and Mountain Dew. That's all I wanted. It was my third year of law school in Florida. I walked into the gas station, grabbed my goods, and went to the counter to begin a day with a friend on his boat. I handed the items over to the clerk, he scanned them with a ubiquitous beep. I slid my card.

—Pause—

"DEEEEEECLINED!" He didn't so much scream it as much as he swung it like a blunt force weapon. The sound came from his not-so-insignificant gut. Like a Viking charging. My friend standing behind me heard him. Everyone heard him. I felt it. My mother, I am sure, felt a surge of disappointment six states away. I didn't have enough money to buy processed cheese and yellow caffeine. My friend who had been standing behind me gently added his items to mine, slid his card, and we left.

Getting declined hurts! It doesn't just hurt. It is personal. Somehow we feel it reflects on us as people. I know someone whose debit card was declined through a processing error—he paid with another card, went to the nearest ATM, printed of a balance receipt, and left it for the waitress to see that he really did have money.

People of all socio-economic classes currently struggle to obtain credit. According to the Federal Reserve Board's April 2009 Senior Loan Officer Opinion Survey on Bank Lending Practices, banks continue to report "tightened credit standards on residential mortgages." So, if you've gotten rejected recently too, you are not alone. People who could get credit three years ago can't get credit now.

While the Viking at the gas station bellowed my rejection, you probably got a consumer credit "Dear John" letter, a.k.a. "Denial Notice". In no uncertain terms you were told "No." You are probably wondering why you received a denial notice, what it means, and what you can do.

The first step is to figure out why you were denied credit. The good news is that federal law grants you the right to obtain specific information. Getting your hands on the reason you were denied may not be easy, but the information can help you learn how to qualify next time.

Two key federal bodies of law provide you the right to receive specific information. First, the Equal Credit Opportunity Act (and Regulation B) prohibit certain discriminatory practices. These laws require creditors to explain the reason they denied you. They require creditors to keep certain records and send you these notices to document the actual reason you were denied. The second federal law requiring the denial notice is the Fair Credit Reporting Act. It requires creditors to tell you if they based your denial on information from a consumer-reporting agency (or other outside source) and to tell you if they obtained certain information from an affiliated company.

These laws mandate specific requirements for your denial letter. When you got denied, your notice was most likely titled: Disclosure of Right To Request Specific Reasons for Credit Denial or a Notice of Action Taken and Statement of Reasons. The first type of notice is very general and tells you that you can ask for more information. The second type of letter is more informative and actually lists the denial reason. If your notice didn't really tell you why you were denied, you can force the creditor to provide a specific reason, as long as you properly contact the creditor within 60 days.

To get the information, send a letter to the creditor at the address provided. Give them your information and tell them in writing that you "would like a statement of specific reasons why your application was denied." Always send your notice by certified mail, return receipt requested.

If your denial notice already included specific reasons, pay attention to those reasons. Creditors establish certain criteria, often called underwriting, and if you meet the criteria, creditors want to lend you money.  This is how they make money and stay in business. It is always possible the creditor may have misunderstood your financial situation.

Maybe you accidentally entered the wrong information on your application. If this is the case, the creditor may be amenable to providing credit if you can update your application with correct information. The creditor might have denied you based on your "length of employment."  While you may have entered "7" as the number of years you have worked for your employer, the credit analyst may have misunderstood your response to mean seven months. Or perhaps the creditor could not contact your credit references and denied you credit instead of notifying you about this problem. If you can alert your references, you may be able to get credit.

These are just examples, but you get the point. Don't curl up into ball or write poetry about it. Investigate it, learn from it, and use the information to your advantage. (And if you already wrote poetry about the experience, please post it!)

If you were denied because of something in your credit report, order your report and see what it says. If it contains inaccuracies, you can correct them with the consumer reporting agencies. 

Naturally, nobody wants to be declined. Certainly, "Dear John" letters don't feel good. That being said, federal law does provide you a great way to figure out what's going on with your credit. The good news is you can take the time to find out why you got denied so it won't happen again.

Justin B. Hosie – Justin Hosie is a member of Chambliss, Bahner & Stophel, P.C.’s Consumer Finance Group, focusing his practice on consumer financial services, the Federal Electronic Signatures Act, Truth in Lending Act, Equal Credit Opportunity Act, and Electronic Funds Transfer Act, as well as state regulatory compliance.

Book Review: The Complete Idiot’s Guide to Person-to-Person Lending

The moment I saw The Complete Idiot's Guide to Person-to-Person Lending, one question immediately came to mind: Where has it been all this time? Person-to-person lending started in the U S with Prosper.com (now Prosper Marketplace) in early 2006. I first heard about Prosper from a Credit.com article. In April 2007 I was officially a lender. But still, without a Complete Idiot’s Guide, this complete idiot went on a lending spree and… well, let’s just say that I’ll try not to ask for a Federal bailout.

Thankfully, you’ll find that the Guide is thorough and leaves no room for error. If you have a strong working knowledge of credit scores and how they are calculated, as well as our current economy and how the current economic climate might all affect a person’s chances of getting a loan, you’ll breeze through “Part 1: The Basics of Person-to-Person Lending.” You might then discover that the Guide really starts with “Part 2: Prime-Time Players in the P2P Marketplace,” which identifies and distinguishes several person-to-person lending sites. I admit I’ve grown attached to Prosper because nearly all my experience lies there. However, I was amazed to find that there are many others including Kiva, VirginMoney, and GreenNote.

Part 3 and Part 4 explore borrowing and lending money, respectively. You’ll find nearly all of this information on the website of the company you get started with. However, if you decide to sit on the sidelines for now—there isn’t much choice with some companies—these sections are definitely worth your time and can save you serious money in the long run. Sharpen your marketing skills to create the perfect listing. This will then get you the best interest rate on your loan. Or diversify your investment into many loans to minimize risk while still maximizing return. You’ll find out how to do it here.

Personally, as a lender, the highlight of this book was the section on taxes, outlined in Part 4. This was unexpected and very refreshing. It was basic but thorough. It works through 1099s and how to handle defaulted loans. The book covers federal and even state income taxes. Also, the Guide is not shy about telling you when a tax professional is needed. I’ve never seen this on a third-party website or blog and I doubt I ever will. The Guide really did its homework. That piece of advice alone is worth the price of this book.

Let’s get back to the first question: Where was this book all this time? Taxes aside, it was everywhere! It was in blogs, on websites (including Credit.com), and in the news. Lucky for us, it’s now in a Complete Idiot’s Guide to help us all navigate this exciting market of person-to-person lending now and as it really takes off in the next few years.

Alex Won is our credit card editor and a peer-to-peer lending network expert. He helps match Credit.com customers with their perfect credit cards everyday. See Alex's top credit card picks online.

Pricing/Locking Scam

You can start out shopping for a mortgage, collect rates on the Internet, talk with loan officers, and so on, but you do not know what rate you will get until you actually lock in your loan. So what is the problem?

Many lenders, especially the big banks, are severely backlogged. They reduced staff in 2008 and simply do not have enough people to handle the huge influx of loans that has occurred in 2009. I talked to a friend who is a senior executive with one such "big bank" and he said they had 200,000 loans in the pipeline. That is over 90 days worth of loans.

What does that mean to you? It means that if you were to apply there today, you will have to wait until 200,000 other loans are processed before they start working on yours. It also means your loan will not get funded for at least 90 days.

Now let's look at this from a lender's perspective. They have 200,000 loans in the pipeline. They know that behind each of those loans are 1+ frustrated borrowers. Here's what they also know:

They know that those frustrated borrowers are still shopping. They know that they will not close all 200,000 loans, even if all were approvable. To offset the likelihood of run-off, in some cases lenders charge a non-refundable application fee. The sole purpose of that fee is to try to keep people "in line" and keep them from straying. Or if they do stray, at least the bank has a few dollars to cover some of the processing costs.

The other thing in the mix is quoting and locking. When they quote rates, it's today’s rate based upon an immediate close. What they don't tell you is that the rates for 45-day, 60-day, and 90-day locks are higher. The rate for a 90-day lock could be higher enough that you wouldn't want to lock in even if you could. So how valid is that low quote they gave you? It's meaningless.

This isn't exactly a scam, but look at it this way. They are luring you to apply based upon low rates today. It may be a teaser because you may not be able to get that low rare when you are ready to close. You will have to take whatever the rates are 60 days from now when you are eligible to lock. In fact, as I write this, rates just jumped up and my guess is that if they don't go back down a bit, they will lose thousands of those loans because they are no longer as economically attractive the borrowers.

That isn't good for the lender either. They really would like to do all 200,000 loans. So why don't they let you lock today? Because they also know from past experience with high backlogs that as soon as they let you lock, you will start shopping again. Maybe YOU wouldn't, but tens of thousands of people will call lenders and say, "I’ve got a loan locked at 5 percent. Can you beat that?" And maybe the market will be such that they can beat 5 percent. In that event, the big bank just lost a loan. 

In fact, if the market moved so much that one guy decided to switch, it is likely that thousands of other people would switch too. That's thousands of lost loans for the big banks.

Advice: You need to put this factor into the shopping equation. The questions you should ask when you call a lender are: "How big is your backlog? When would my loan be approved if I applied today? When will I be able to lock in my rate?" If they say you can do a long-term lock, ask them: "What is the rate? What is the rate for loans approved today?"

I think that you will likely end up dealing with the lender who can deliver your loan sooner rather than later. And you'd better avoid dealing with someone who has a great rate but won't or can't lock you in. It's likely that it's a scam.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles, Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.

Fannie and Freddie's Regulator Received an Award? Why?!

I am a big believer in the regulation of the mortgage industry. Many borrowers are clueless, while the opportunities for lender mischief are great; for this reason, more regulation is needed. This statement might surprise you coming from a conservative guy like me. But the following really gets to me...

The Federal Housing Finance Agency (not to be confused with FHA, or the Federal Housing Authority, which insures FHA loans) was responsible for regulating Fannie Mae and Freddie Mac and now acts as their conservator, i.e. "nanny." The FHFA just announced that they received an award, the CEAR Award For Fiscal Responsibility and Accountability.

According to a news release from FHFA, "The CEAR (Certificate of Excellence in Accountability Reporting) is the highest award for outstanding accountability reporting in the federal government."

This news astonishes me – if there is one agency of the federal government that does not deserve praise, it is this one. It is instructive to examine the track record of this agency, formerly known as the Office of Housing Enterprise Oversight. Let's set the stage...

In 2004, the combined shareholder value of both Fannie Mae and Freddie Mac was $134 billion. Shortly thereafter began accounting scandals that allegedly resulted from manipulating of earnings. It seems to me that when regulators regulate and when auditors audit, they are supposed to reveal inconsistencies in regulation and accounting respectively. So, looking back now, we'd have to account for the oversight that did occur as a failure.

Next was the issue of exorbitant executive bonuses based upon these fraudulent earnings. Franklin Raines and two other executives were named in a civil suit wherein OFHEO attempted to get them to return bonuses paid on inflated earnings. The suit asked for $110 million in penalties and return of $120 million. It was ultimately settled for $3 million in penalties, and those were actually paid by Fannie Mae’s insurance company. Fannie Mae also ended up paying a $400 million civil fine. Another failure.

The successor CEO was Daniel Mudd who was CEO until he was fired in late 2008 when FHFA took over Fannie Mae. He was paid some $80 million during his tenure at Fannie Mae. Another failure

The stories at Freddie Mac aren't very different with earnings manipulations. A 2005 story in the New York Times:

"The size of the restatement also prompted some lawmakers and regulators to raise anew their concerns about how Freddie Mac is regulated and to call for more stringent oversight." 

More failures, but apparently no one in Washington read this article. Today, of course, not only has the $134 billion in shareholder value gone but the enterprises are in hock to the federal government for something approaching $100 billion. That’s a swing of almost a QUARTER OF A TRILLION dollars. That is about five times bigger than the Savings and Loan disaster 20 years ago. In fact, it must be the greatest single regulatory failure in the history of the planet. 

So for all of this wonderful regulation, FHFA will receive an award... For what? 

On the brighter side, according to notes at Wikipedia, in 2004 Working Mothers magazine named Freddie Mac one of the 100 best companies for working mothers. 

All of this and more is detailed in the book Fannie Mae and Freddie Mac: Scandal in U.S. Housing.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles, Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.

Fannie Mae and Freddie Mac: Do We Need Them?

The short answer is, "You'd better believe it!"

The long answer is that along with FHA, Fannie Mae and Freddie Mac ARE the mortgage market today. If you shut down these conduits, the housing market comes to a screeching halt, and I shudder to think of the repercussions of that on our economy. It would be devastating – a lot worse than it is now. 

Due to accumulated losses, both institutions have significant negative net worth, effectively wiping out the shareholders. The government's financial position is in preferred stock, which has a higher priority than the common stock that is worthless from a book value standpoint (but still trading at about $1 per share).

Fannie Mae recently announced a $23 billion loss for the first quarter of 2009 and Freddie Mac just announced a $10 billion loss. Both asked the Treasury Department for more money to shore up their balance sheets.

Now, even though I have an MBA, working through the accounting is beyond my capabilities. I do understand that most of the losses are due to write-downs in the estimated value of loans that are on their books or which they have guaranteed. If a $1 billion pool of mortgages is now valued at $600 million, the result is a $400 million write-down and a $400 million loss. We don’t know what the real losses might be until the loan is paid off or foreclosed upon and the property sold.

You will recall that both institutions came under considerable fire a few years ago for "fooling around" with earnings. Allegedly, management paid top executives bonuses totaling over $100 million – money that they arguably did not deserve.

In part, the difficulty in making sense of the financial situation is due to the fact that the accounting is complex. Over the years the managers fooled their Boards, auditors, regulators, bondholders, and shareholders. So it's understandable that the current numbers are incomprehensible to ordinary human beings today.

Included in the 206-page first-quarter report, filed with the Securities and Exchange Commission, appears the following:

"Our expectation [is] that, for the foreseeable future, our earnings, if any, will not be sufficient to pay the dividends on the senior preferred stock..."

That means that they cannot pay the dividends on the stock we taxpayers have in the business. They will have to borrow more to make these payments. 

"Our expectation [is] that we will not operate profitably in the foreseeable future, and [it is] our belief that there is significant uncertainty as to our long-term financial sustainability."

With a $20 billion negative net worth, they are right.

"[We believe] that the actual and perceived risk that we will be unable to refinance our debt as it becomes due is likely to increase substantially as we progress toward December 31, 2009, which is the date on which the Treasury credit facility terminates."

With further write-downs on the horizon, this means that the government – read: taxpayers – have a permanent stake in Fannie and Freddie.

The good news is that no one in Washington, D.C., is going to let them fail. Around $400 billion has already been pledged to keep them afloat. Both institutions are doing lots of business – about $300 billion in the first quarter. Let's assume that they are making money on that business.

A summary of the first quarter activity at Fannie Mae makes very interesting reading – I highly recommend it.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles, Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.

More problems at Fannie Mae… but there are reasons to hope

The nation’s largest real estate financier, Fannie Mae, just announced a loss of $23.2 billion for the first quarter. This number almost equals the loss of $25.32 billion during the 4th quarter of 2008.  Fannie Mae now has a negative net worth of $19 billion.

Those are staggering numbers, and some would say that they represent a continuing deterioration in the housing market. As a result of the losses, Fannie Mae has asked for an additional $19 billion in funds from the government.

Fannie Mae now owns some 62,000 homes that it acquired through foreclosure, just about the same number as on December 31st, 2008. They acquired 25,000 homes through foreclosure since then, which must mean that they also sold 25,000 foreclosed homes. This was during a period when Fannie Mae had largely suspended foreclosures. This must mean that, in spite of Fannie Mae’s efforts, those 25,000 additional foreclosure cases must have been hopeless, with no potential for recovery. The rate of loan modifications was modest compared with the total number of distressed homes.

So what's the good news?

First, financing activity has been spurred by historically low interest rates.  According to a recent Fannie Mae press release, lenders sold  $175 billion in new loans to Fannie Mae in the 1st quarter of 2009.  Of course, much of that was refinance activity. With rates below 5 percent, even consumers who financed their homes in 2008 at 6 percent can benefit from a refinance. Indeed, at my business, most of our recent activity has been through refinancing for borrowers who completed loans with us in just the past few years.

Another reason for hope is the new refinance programs announced by Fannie Mae and Freddie Mac that will allow borrowers, even those who owe more than the current values of their homes, to take advantage of these lower rates. The program is available for homeowners who owe between 80-105 percent of the value of their homes without requiring Private Mortgage Insurance (PMI). To find out if this program might benefit you, visit Makinghomeaffordable.gov/.

Additionally, there have been a healthy number of purchases in the past few months. This purchasing trend indicates a resurgence of nationwide interest in real estate.  As values have dropped, buyers are finally coming off of the sidelines and buying homes. Quite frankly, with values AND mortgage rates so low, a situation emerges in which many more people can find affordable homes.

If you are a prospective homebuyer, I hope that this news will give you some encouragement.  It's a great time to buy!

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles, Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.