Banking and Housing Giants Testify About Subprime Solutions

The chief executives of both Freddie Mac and Fannie Mae as well as the Chairman of the Federal Deposit Insurance Corporation and the Federal Housing Commissioner and Assistant Secretary of the Department of Housing and Urban Development testified last week in a hearing before the U.S. House Committee on Financial Services about solutions to the current subprime mortgage turmoil.

Each of the four had some interesting things to say about what their organizations/agencies are doing or could be doing to resolve the situation and we will, in a couple of installments, cover them all.

Fannie Mae's Daniel H. Mudd, in a statement prepared for delivery said that his corporation sounded the alarm about the impending subprime crisis in early 2005 as they recognized the dangers of "layered-risk" lending and decided that the products that offered borrowers a mix of teaser rates, interest-only, negative amortization, and payment option and low-doc requirements coupled with adjustable rate loans were for more sophisticated buyers. The corporation decided then that it made no sense for borrowers to take on risks that they might not be aware of; to set them up for failure.

Fannie Mae thus, he said, instituted a disciplined approach to that market, applying a "strict 11-point anti-predatory lending standards to our loan purchases. Under this policy we reject loans the borrower can't afford to pay from the start, those with excessive points or fees or subject to mandatory arbitration; loans with abusive prepayment penalties with single-premium credit insurance or debt cancellation insurance. And, of course, any loans that are illegal."

"As a result, we gave up significant market share to our competitors. At the same time, we continued our careful entry into the subprime market, by and large supporting lenders, products and practices that met our standards, and which helped us meet our HUD affordable housing requirements."

Consequently, Mudd said, Fannie Mae's exposure remains relatively minimal -- less than 2.5 percent of the Corporation's book of business can be defined as subprime and, while this has helped protect the company, its lenders and borrowers during the crisis, it has also given the company some room to support the market, as Congress intended. "We are a secondary market mortgage company -- we can't solve all the problems, but we can't wash our hands of them, either."

Mudd did not agree that the larger market should cut off financing for the subprime segment which would only make it more difficult and costly for the least fortunate borrowers to finance or refinance their homes. He quoted Robert Gnaizda of the Greenlining Institute as saying "Arbitrary and artificial tightening of credit may be counterproductive - that is, it may dry up credit for members of minority groups, the poor, and the 70 percent of Americans who live paycheck to paycheck."

Mudd advocated getting ahead of the problem by assisting borrowers who are not yet in trouble. "We want to help prevent further disruption of the subprime market, which would make it tougher for these borrowers to refinance into better, safer loans. To this end, Fannie has established a new company initiative nicknamed "Homestay" which has three basic parts.

• The company works with lenders to help homeowners avoid immediate foreclosure. The company has an operation that focuses on helping people who are falling behind on payments to avoid default. If it is a Fannie mortgage the company will work with lenders or services to offer a range of workout solutions along with offering lenders financial incentives to help borrowers avoid foreclosure. Mudd stated that the corporation worked out 27,000 loan modifications last year and also has programs in place to help lenders identify vulnerable borrowers and methods to refer borrowers that are not on Fannie's books to places they might receive help.
  
• Fannie is expanding lending options to assist lenders refinance homeowners out of high-reset ARMS or other loans that may be problematic. The HomeStay initiative "makes these products more flexible and broadly available and includes low down payments, long-term fixed rates, low fees and points, a prohibition of pre-payment penalties, and a ban on arbitration clauses. Credit requirements are being adjusted so that many homeowners facing payment shock will be able to refinance into Fannie supported loans without requiring they clear up unpaid bills on their credit reports. The company is also relying on its experience with blemished credit to expand the previous subprime product from 500 lenders to some 2000 accredited lenders while stretching maximum loan terms from 30 to 40 years.
  
  Mudd said the Fannie is currently getting at least 15,000 applications for subprime refinancing each month and that 80 percent of these applications have been accepted. Thus, some 1.5 million homeowners facing resetting ARMs could be eligible for Fannie Mae loan options.
  
• The company helping to counsel future homeowners, especially those who are most vulnerable, or for those whom a product modification alone will not save the day. The goal is to help people know what to do before payment shock hits, and to avoid making the wrong mortgage choice in the first place.
  
  He cited $5 million in grants this year to support a national foreclosure prevention initiative being managed by NeighborWorks of America and the Homeownership Preservation Foundation. Such nonprofit organizations join with local governments, other nonprofit organizations, borrowers and lenders to help families overcome obstacles that could result in the loss of their homes.
  
• Mudd also cited additional educational programs such as a "Know Your Mortgage" effort, providing lenders with fact sheets with easy-to-understand descriptions of mortgage terms in English and Spanish for use with borrowers and an expanded distribution of its Home Counselor Online system to lenders, organizations and agencies. This web-based application is designed to help people understand the home-buying process, how to protect or fix their credit, what to demand and what to avoid.

"Finally," Mudd said, "as we help the subprime market through this turmoil, Fannie Mae will continue to support better lending guidelines. When banking regulators finalize the new guidelines regarding teaser ARMs, which should be soon, we will work with our industry partners to comply with them. From the start, we said we believed the best course of action would be to follow the regulatory process to avoid further disruption of the subprime market and the borrowers who depend on it. That's what we're going to do."