Our Government Sponsored Enterprises (GSEs), Fannie Mae and Freddie Mac, have offices located “just across the river” from each other. The Potomac may be getting wider. The GSEs have been effectively owned by the public since the “great recession,” where public dollars bailed out these institutions. Will this change soon?
We have changes: In regulation, forms, ownership, and business models.
The community has been disturbed recently by new developments. Yes, change is coming. Yes, change is near. No, no one really knows how this is going to go. Each stakeholder sees things through different eyes – Appraisers, banks, Appraisal Management Companies (AMCs), underwriters, risk analysts, and the public. Yet, what is really apparent, is that these GSEs are experiencing a new disturbance of their own.
The GSEs are important to all contributors to collateral assessment. This includes originators such as banks, intermediaries such as AMCs, providers of property value such as automated valuation models (AVMs) – as well as appraisers and non-licensed evaluators. Remember that Fannie Mae and Freddie Mac also influence other governmental and non-governmental institutions, such as the VA, HUD, credit unions, and the larger (and smaller) bank lenders.
To Understand Your Future
To form a personal strategy for future success requires we understand the motives, constraints, and the stated purpose of these important institutions. To draw a useful map, we must see the roads as well as the rabbit trails. We need to know who uses the paths and who maintains them. And most importantly, we need to know where we are now.
At the recent Valuation Expo in Las Vegas, we heard GSE representatives reveal the current thinking about appraisals, AMCs, and their relationship with primary lenders. While the official stated positions can be guarded, we can see some of the future by seeing the present, and the trajectory of movement. If we know where we are today, and the probable roads to the future, we can imagine that future. We can begin to prepare by going that direction, even if we don’t know exactly the end point.
We need to know where we are, the direction to go, and the choices of roads going that way.
The trajectory is defined and predicted by three controlling influences:
- What are current and recent GSE practices and policies?
- What are the current and probable regulatory changes?
- The sound and the beat of information technology?
Current policies, practices, and routines set the place on the map. They are our starting point. Before the map can help us explore what may be, we must understand where we are now.
First, GSEs may become just “Es”- fully privatized. On one hand, we have the Federal Housing Finance Administration (FHFA) with effective overall control. On the other hand, we have the current executive branch of our government stating the intended removal of that control. In fact, one proclamation has been that, not only will Fannie Mae and Freddie Mac be released from government assurance, but that additional competition may be encouraged. This is an ocean change like the melting of the north and south poles.
Second, the public policy platform will not persist. Change is reflective of both political parties’ intents.
Third, technology transformation is taking a turn. The digital drive is here. The new roads all require attention to digital disruption and conscious concern. Ignorance, avoidance, and insistence on past practice, is peril.
In particular, we rely on the presentations made by Scott Reuter of Freddie Mac, and Lyle Radke of Fannie Mae. We also were able to view draft versions of the new forms.
Existing Policies, Practices, and Expectations
- The Mission:
“Fannie Mae” is a leader in providing housing finance for homebuyers and renters in the United States. We serve the people who house America. Together with our partners, we make sure that homeowners, homebuyers, and renters across the country have access to affordable financing opportunities.
“Freddie Mac was chartered by Congress in 1970 with a public mission to stabilize the nation’s residential mortgage markets and expand opportunities for home ownership and affordable rental housing. Our statutory mission is to provide liquidity, stability and affordability to the U.S. housing market.”
As was elegantly and simply put by Mr. Reuter: “We manage risk.” This instantly sets up a tension. While the mission is to enable affordable housing and financing, the profit motive rightfully remains. The profit motive encourages efficiency.
So how does risk come into the picture? It is simple. My risk – If I give (lend) you money, what are the chances of me getting it all back, and making a profit? What is my risk of loss? I have to balance out a few losses against a steady gain on most of my loans.
What happened in the “great recession” is that government backing was required to bail out the GSEs. Because there were so many losses, the government had to step in to prevent an even greater economic failure. That’s you and me!
In the past, per Mr. Radke, the GSEs had low levels of ‘forensics’ and bought everything brought to them from originators. Today, “we want insights into what we are buying.” With 17 million loans per year, what is needed is a better system to triage, based on risk. The need is a digital model. This tells us the direction of analytic things.
Individual loan risk varies, and it meanders.
The Fannie/Freddie cooperation on Uniform Appraisal Dataset (UAD) is a way to move toward scoring and risk-rating individual loans. The Uniform Mortgage Data Program (UMDP) expands the concept to all aspects of asset, borrower, and even market assessment. To measure something, that something needs a consistent name and a clear data level (type).
You must measure meander to manage the model.
The good news is that it appears to have been the right thing to do. Today, the government has been paid back its coverage, and the GSEs are eligible to return to the quasi-governmental guidance, rather than being fully answerable to the government in the form of the FHFA. The FHFA also regulates the 11 Federal Home Loan Banks that provide liquidity to member financial institutions.
There are several types of risks in lending. (See George Dell’s multipart series “What’s All This Stuff About Risk?”)
For our purpose, here we can consider just three kinds of risk:
- Borrower risk – ability to make monthly payments
- Collateral risk – the property value is not enough, in the case of payments default
- Market risk – the market being unable to provide a price in the case of payments default
Here is the problem. Each of these are interrelated. The market drops and creates a vacuum. Then property value drops and the borrower loses employment, in tandem. Recession brings on losses. I call this a “vacuous circle.”
And note the social losses from people losing their homes, their jobs, children’s future, their relationships, their self-esteem, their joy, and contribution.
So, the GSEs on one hand have a responsibility to make a profit, to manage risk. Yet we the people expect them to help make financing affordable, provide stability, and provide opportunities for affordable housing.
Well heck, anyone can do that!
Well heck! It looks like the GSEs have some of the same conflict of purpose as appraisers:
Appraiser message: “Please give me the number I really need, and be ethical while you do it!”
GSE message: “Please provide low interest loans and maximize profit while you do it!”
3. Let’s Make Money!
The GSEs do not make loans. So how do they make money? The GSEs buy and guarantee loans and packages of loans. They also sell pool packages of loans to resell mortgage-backed securities (MBS), to insurance companies, pension funds, and investment banks.
Lyle Radke (Director of Collateral Policy at Fannie Mae) provides a clear outline of how Fannie Mae optimizes this side of the risk/profit effort. Three ways Fannie Mae makes income:
- Fees. They create bonds and guarantee loans.
- Sell an income stream. Some of these are guaranteed, others carry no guarantee. Effectively, they are mortgage loan insurers. The only thing important here is risk. Different groups (tranches) of risk carry different levels of income. There is a trade-off. Risk is the measure, nothing else.
- Clean up. When loans do default, someone has to manage the process. There are only three things really important here:
- Frequency of default (what % of the loans get into trouble)
- Size of the default (Is there a net loss, and how large is any loss.)
- Detection, proactively, of the default or probability of a default.
Again, it is all about risk. How often, how big, and how manageable is the loss.
This brings us to the role of valuation and analytics in managing risk. But now we look at the front end of the risk equation. How do the GSEs predict overall risk from the borrower, the property, and the market trend?
The New Forms – The Front End
At Valuation Expo, Fannie Mae and Freddie Mac presented a draft version of the new forms for residential appraisals. They are thorough, tedious, tentative, and they were displayed at the UAD Joint Booth. As a side note, it is important to remember that Fannie Mae and Freddie Mac are competing businesses. They cannot collude due to antitrust laws, among other things. Currently, they have ‘orders’ from FHFA to cooperate on data standardization, so they do so.
Sean Murphy, a subject-matter expert for Freddie Mac, and Sergio Johnson, a member of Fannie Mae’s Collateral Policy and Strategy team, also provided input into these topics. Here’s what we have so far:
- One form for all property types. This may seem clumsy under old appraisal thinking patterns. However, we note that times have changed. The old forms are old. They were created in the days of 8 ½ by 11-inch paper, which was convenient in two ways: Three comps seemed about a right fit for the size, and three comps are easy for the human brain to envision. Second, data used to be difficult to gather. My routine was to find 7 or 8 out of the MLS, cut it down to 5 or 6 in the field (after the inspection), then cut it down to 3 (using 4 or 5 if I needed to bracket any major ‘elements of comparison’).
- More detail. This new, evolving ‘form’ is intended to be more thorough. Detail and coverage of the UAD palate of fields needs to be addressed. This creates a form of 10-12 pages! Hmmmm. Is this simpler? And how does this go with the idea of division of duties in appraisal?
In addition, there is likely to be attention to Green items, zoning, weighting of comps, reporting of “additional” sales, defects/damages/deficiencies, and quality/condition ratings. Also access, view, water frontage, environmental, site characteristics, utilities, room detail, mechanical systems, accessibility, kitchen/baths quality/condition, and functional obsolescence issues.
Whew! I see tension. It is between wanting/needing broader, detailed data – reported with discrete values – and the potential cost/training needed to properly gather this data. It will take training as well as dynamic, data-driven software. This may be a greater challenge than is anticipated, in my humble opinion.
- Robust. The ‘form’ in a sense will not be a form! It may not be immediately, but in the long run, the inevitable end will be a universal data frame. The data frame will be accessed by various users via specialized dashboards.
- The field data collector will have a dashboard, likely a portable device.
- The asset analyst© or appraiser will have a different dashboard, oriented toward model and algorithm selections, visuals, statistical, and narrative explanations.
- The reviewer/auditor/underwriter will have yet another dashboard, focused on reproducibility elements and review of documented appraiser modeling decisions, appropriate to the specific judgments needed.
- Portfolio manager dashboards will focus on – yes – risk.
- Management dashboards can also be set up easily to focus on decision-making.
Our GSEs are important to the economic and social health of this country, and beyond. It appears they may be given “too big to fail” status as systemically important financial market utilities (SIFMUs). Remember the bifurcated goals of the GSEs: 1) make a profit. 2) provide access to affordable finance for housing.
This is a difficult but worthy challenge for our GSEs. And the focus is all about – RISK.
The consumer and the taxpayer will be better served through the careful attention that I now see in progress. I trust it will continue with care and competence. I have reason to believe so.
The valuation function will continue, and it will continue to change. We will need more, much more than an opinion two weeks old. We will need more. The starting point will be market price. And appraisers who qualify as asset analysts© will have a place of value, esteem, and service.
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