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Secondary market.


There is much talk today about whether or not a credit crunch exists. To a large extent, bank and thrift regulatory pressures have fueled this controversy. The implementation of FIRREA has taken a significant number of thrifts out of the lending business. So is there really a credit crunch? Well, just ask Sir Donald de Trump. Even though many types of businesses are beginning to feel the pinch of a credit crunch, mortgage lending has been relatively immune from credit restrictions because of the free flow of credit obtained through the secondary market agencies. Because these agencies are not directly affected by bank/thrift regulatory actions, the so-called "credit crunch" has missed these agencies and their participating seller/servicers and mortgage borrowers.

In the context of credit availability for mortgage lending through the secondary market, the more critical question to ask is: under what conditions might a mortgage lending credit crunch occur? The most significant set of events that could potentially affect the availablity of mortgage credit involve recommendations contained in the Treasury report to Congress on government-sponsored enterpirses (GSEs) and the Price Waterhouse report to HUD on the FHA fund.

Treasury sets forth public policy parameters it believes should guide the relationship between the U.S. government and GSEs like Fannie Mae and Freddie Mac. These guidelines include the following: * Fannie Mae and Freddie (along with other GSEs) should

obtain a triple-A rating (absent the implicit federal guarantee)

within five years from at least two nationally

recognized credit rating services; * The two secondary market agencies should be subject to

two levels of regulation: 1) safety and soundness; and 2)

program implementation; and the regulatory oversight

should be provided by separate entities; * The agencies should be adequately capitalized, meet high

credit and operational standards and be subject to effective

government supervision or face termination of

government support; and * The agencies should quantify and disclose the amount of

federal support they receive in each annual federal government budget.

At this time, it is not clear that these policy statements by Treasury will result in a legislative proposal. We hope not, because requiring the agency to reach a triple-A rating and political pressure is very likely to result in less mortgage credit. Here's why.

Although not triple-A, both Fannie Mae and Freddie Mac securities are currently considered to be investment grade absent the implicit federal guarantee. The most important element in obtaining a triple-A rating is reducing leverage to acceptable levels. These agencies have available to them a limited number of options to do this. They may: 1) reduce the amount of earnings paid as dividends; 2) sell additional equity interests in the corporation; 3) borrow less; 4) increase fees; 5) decrease costs; or 6) choose any combination of the foregoing.

Reduce dividends - This approach is not likely to be pursued for two reasons. First, dividends on agency stock are not very high to begin with. The reduction in dividend payout would not be that helpful. Second, common stock investors do not like radical changes in dividend payout policies. A significant reduction in dividends could result in stock devaluation which, in turn, will mean lower stock prices and a higher cost of equity capital.

Sell more stock - This is a very real possibility - especially in the near term, while the Dow is at record high levels. If the agencies wait until the stock market goes south, they could be in real serious trouble.

Borrow less - This is probably the easiest to implement but it is the alternative having the greatest and the most direct impact on mortgage credit availability. This alternative will be more important to Fannie Mae than to Freddie Mac because of Fannie's significant activities as a portfolio lender and its higher leverage position. To borrow less means to purchase less in the way to mortgages. Fewer mortgage purchases mean less mortgage credit and probably more selective purchases.

Increase fees - This is also relatively easy to do but painful to the mortgage lending community.

Decrease costs - This is certain to be one of the options selected and used in combination with other alternatives. Decreasing costs show that management is acting responsibly. Such an approach could affect participating lenders because the most likely target for cost reduction would involve limiting losses associated with underwriting. Without question, tighter underwriting and fewer negotiated transactions will probably result in fewer losses associated with borrower defaults. It will also mean tighter mortgage credit because it will be more difficult for borrowers to qualify.

In all likelihood, the agencies will elect to use all of the foregoing options and several others to some degree. Even if the agencies are not forced to obtain a triple-A rating, the Treasury statement coming during the current thrift bailout environment places these agencies in the position of having to move in a direction that reduces the likelihood of a taxpayer bailout. Recognizing the inevitability of this, the MBA will be studying the following: the reasonableness of establishing a triple-A standard for the agencies to meet, in light of their public mission; the appropriate regulator(s) for the agencies and the scope of regulation; and whether or not five years is sufficient enough time to achieve triple-A status while carrying out the public mission.

Last, for government lenders, the prospect of some tightening of mortgage credit is a real possibility. A recent HUD commissioned study of the FHA insurance fund claims the insurance fund is in trouble. Based on this study, HUD is now proposing to take measures that will boost the funds capital adequacy. MBA will be closely monitoring this development to ensure that the fund remains solvent without unduly restricting the flow of FHA mortgage credit.
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Title Annotation:mortgage lending and the credit crunch
Author:Taliefero, Michael S.
Publication:Mortgage Banking
Date:Jul 1, 1990
Previous Article:Lending liability legislation.
Next Article:Economic trends.

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