The Rise and Fall of Fannie Mae and Freddie Mac
by Henry S. Harrison

Last June, I answered an “Ask Henry” question from a reader: “When will the residential real estate recession end?” My answer was that I thought that it would end in the term of whoever was elected President in November 2016. Between June and when Barack Obama was reelected President, the news media was full of press releases and commentator predictions that the country was well on its way to a real estate recovery.

Real Estate Appraisers — whose livelihood is closely tied to the fate of Fannie Mae and Freddie Mac — as a group seem to be ignoring how the future of these two organizations will affect their businesses. The latest figures show that these two giants are now guaranteeing about 90% of all the single family home mortgages in the US.

On December 29, 2000, the price of Fannie Mae stock hit an all-time high of $86.75 per share. Eleven years later, it hit rock bottom at a low of $0.20 per share. As of September 18, 2013, it closed at $1.17 per share. So the question remains, why is it trading at all, given the government takeover?

The answer is there are a number of people and hedge funds who believe that Fannie Mae and Freddie Mac will survive the present governmental conservatorship and will once again become publicly traded companies. What makes this unlikely, in my opinion, is that the government created a new government senior preferred shares which placed the common stock last in line to receive any assets of the company that remain if and when the conservatorship is terminated. If you are looking for a very long shot investment, Fannie Mae stock should be considered. Your stock broker should be able to tell you how to do this. However, this is not a recommendation.

Most appraisers know that Fannie Mae and Freddie Mac are in trouble. But who they are and what they have done politically to prompt the federal government to announce it is standing by with a possible multibillion-dollar bailout remains unknown to most.

Here is their history.



When will the Housing Market return to Normal?
by Henry S. Harrison

Last June, I answered an “Ask Henry” question from a reader: “When will the Residential Real Estate recession end?” My answer was that I thought that it would end beyond the term of whoever was elected President in November 2012. Between June and when Barack Obama was reelected President, the news media was full of press releases and commentator predictions that the country was well on its way to a real estate recovery.

On February 12, 2013, I listened to the President’s State of the Union Address. Here is what he said about the real estate recovery:

“Our housing market is healing, our stock market is rebounding, and consumers, patients, and homeowners enjoy stronger protections than ever before… Together, we have cleared away the rubble of crisis, and can say with renewed confidence that the state of our Union is stronger…Part of our rebuilding effort must also involve our housing sector. Today, our housing market is finally healing from the collapse of 2007. Home prices are rising at the fastest pace in six years, home purchases are up nearly 50 percent, and construction is expanding again… These initiatives in manufacturing, energy, infrastructure, and housing will help entrepreneurs and small business owners expand and create new jobs. But none of it will matter unless we also equip our citizens with the skills and training to fill those jobs. And that has to start at the earliest possible age…We’ll work with local leaders to target resources at public safety, education, and housing.”



When Will the Residential Real Estate Recession End? (Part II)

On October 11th, the Federal Reserve lowered its forecast for growth slightly this year and forecast that the economy would grow slightly in 2013. I stated in my June Editorial (below, dated 6/03/12) that the key to the overall economic recovery, and especially to the recovery of the residential housing market, is new construction.

Here are the annual housing starts as reported by the US Census:
US census data

You don’t have to be an economist to understand what these figures are saying. To me, this table shows that all things being equal, we can absorb about 1,500 million single family houses per year, and starting in 1999, we started to over build. To absorb these extra houses, lenders sold homes to people who previously would not have qualified to buy them.

housing data graph

Once we absorb these extra houses, we should be able to build and absorb another 1,500,000 houses per year. Think what this will do for the economy! Millions of new jobs just to build the houses and millions more to produce what goes into them.

The bottom line is that it is hard to sell news when comparable used houses can be purchased at a much lower price. So far I don’t see much happening to rehabilitate and sell off the houses that have been foreclosed, plus at least another million houses that will be foreclosed in the next few years.

So to repeat my forecast made below from June 2012: In spite of what you read as part of the election campaign rhetoric, nothing much is going to happen in the next few years to improve the overall housing market. Keep in mind that as there will be local markets that buck the national trend and will improve sooner, and others that will improve slower.



When Will the Residential Real Estate Recession End?

Soon, later or never? I predict it will last beyond the term of whomever is elected president this fall.

In 2005, my neighbor, the Yale economist Robert Shiller, predicted in “Irrational Exuberance, 2nd Edition” that the Housing Bubble would soon burst. He was called Dr. Doom in the media, and ignored by most people, especially those in government who might have done something to avert the pending crisis.

The bubble did not burst all at once, as in a stock market crash, but rather, values fell more gradually in some markets and much faster in others, proving once again that there is no "national" real estate market in the country, but rather many different markets, each highly dependent upon location (location, location, location).

Now we are coming up to a national election in the fall of 2012 and we keep hearing murmurs that the end is in sight. This may be true in some localities, like the San Francisco Bay area, but I believe it is wishful thinking in most places in the United States. During 2011, over a million houses were actually foreclosed or sold via short sales. Almost double that number entered into the foreclosure process. The current slow down in foreclosures is not due to the improved economy but rather to a slow down caused by the courts, who are now insisting that the foreclosure documents be legally correct. (Revelations of widespread fraud in document preparation has led to what is probably a temporary reprieve for many homeowners who are currently under water.) There are now about 100 million detached single family homes in the United States of which nearly 15 million are underwater. Furthermore millions of them are vacant.

Here is my own experience, which I believe is typical for Florida and many other parts of the country. The house that we purchased three years ago was built in 1995, at a cost including the site of about $225,000. At its peak in 2005, it was worth about $375,000. We bought it for $130,000 and today it would sell for about $110,000. The cost to build it today would be about the same as in 1995, that it, about $225,000. In our solvent 55+ development with nearly 800 units, about 10% of the houses are on the market. This figure has been constant for the past three years, because as fast as houses are being sold, others come on the market. There are practically no new houses being built in our market area. And there is nothing on the horizon that I can see that is going to significantly change this picture in the near future.

I know two families whose homes have been in foreclosure for over a year. Neither of them make any payments on their mortgage, or pay any taxes. If they were served papers today, it would take six months to a year to actually foreclose their homes and get them out. The lender would then have to fix up the houses, which both have deferred maintenance, and will likely take a 25% to 50% loss on both properties. Their neighbors who have been making their payments all along feel like fools whenever they learn that a delinquent homeowner is not only not being foreclosed on, but often having their mortgage renegotiated with more favorable terms. It makes those folks who are "playing by the rules" feel duped by the system.

I don’t see any quick fix to this problem. What will happen if the government forces the banks to "write down" the mortgages for delinquent homeowners — and doesn't do something similar for those people who've been making their payments all along, even though the value of their home has fallen below the unpaid amount of their mortgage?

I know from what I hear first hand and read that these two examples are duplicated in millions of situations throughout the country. When the bubble burst, those of us who predicted it would take at least 10 years for a recovery were accused of being "gloom and doomers." I predict that in 2015, we will be thought of as too optimistic!



May You Live In Interesting Times...

We all probably know the playful Chinese curse: "May you live in interesting times." Watching the current political gambits on TV and YouTube it certainly reminds us that we live in a new instant age. Unfortunately, at least so far, this "silly season" seems to be a lot more about entertainment than substance.

The political process at the moment appears to be primarily (pun intended) a media and money circus, rather than a realistic and practical discussion of the work that needs to be done to deal with America's real problems, both economic and social.

Given our current economic doldrums, and the continuing problems of unfair taxation, high unemployment, millions of Americans still without health care, and the dismal condition of our infrastructure, it's easy to become disheartened.

Still, I feel that there's real hope to focus on.

Although we are firmly part of a global economy now, America continues to be the one country that still offers the most personal opportunity, growth, innovation and success for millions of people from thousands of diverse backgrounds.

We have all THE BASICS right here. Our economy is vast, responsive and solid under the current turbulence. Let's hope 2012 proves to be a year of wisdom, power and potency, for our country, its leaders...and our profession!



Editorial: Senate Debates Additional Flood Coverage

Having just lived through Hurricane Irene, and the significant tidal flood damage done to our summer cottage in Long Island Sound from the 7 foot storm surge added to our normal high tide of 8 feet, this article struck our attention.

The GOOD NEWS: My own experience dealing with FEMA personnel in a difficult situation has been surprising, given their less than stellar reputation.I found them to be professional, courteous and genuinely helpful. In our area of the Connecticut shoreline there was a great deal of damage, including the wash-out of many of our main access roads. Nonetheless, the FEMA adjusters showed up and did their job of assessing the damage in a timely manner.

At issue in Congress now are new requirements for flood insurance coverage in residential and business areas near levees, dams and other flood-control structures.

According to a report October 19th in Property Casualty 360, two Gulf-Coast senators are seeking to remove a Senate flood-insurance legislation provision requiring flood coverage in areas already protected by levees, dams or other flood-control structures. Sen. Thad Cochran, R-Miss., and Mark Pryor, D-Ark., announced late Monday that they are seeking to have Sec. 107 of the National Flood Insurance Program Reauthorization Bill deleted from the proposal. The provision was included in a bill that was reported out of the Senate Banking Committee Sept. 8.

Cochran and Pryor are raising the issue despite the fact that the Senate is working under the pressure to pass another temporary extension of the National Floord Insurance Program (NFIP), now slated to sunset Nov. 18.

The Senate must pass a bill, then reconcile its version with a somewhat different House bill, H.R. 1309, the Flood Insurance Reform Act of 2011, before that date, or NFIP will lapse.

Seems Congress is once again playing brinksmanship with America's flood insurance program. After our recent experience, that doesn't seem wise to us.

Summer Cottage "Pre-Irene":

Post-Irene Damage from Tidal Flooding:

Matt Gannon, assistant vice president of federal affairs for the National Association of Mutual Insurance Companies, voices sympathy for the concerns of Cochran and Pryor, but adds that the Senate bill’s Technical Mapping Advisory Council was established to address this very type of issue. But Cochran and Pryor say they are asking their colleagues to join them in signing a bipartisan letter to the banking panel asking for reconsideration of Sec. 107. This provision would have expanded required insurance coverage to “areas of residual risk” that are located behind levees, near dams or other flood-control structures.

“The NFIP must be reformed, and I believe the Senate Banking Committee has done yeoman’s work on crafting bipartisan reform legislation,” Cochran says. But he notes that Sec. 107 creates new flood insurance coverage mandates on families and businesses that are already protected by strong levees and dams, and believe that "the blanket approach taken in the current bill should be changed in order to ensure fair treatment for those protected properties."


Editorial: The Debt Bill (Budget Control Act of 2011)

It is easy to become depressed when you follow the news these days.Unemployment seems to be stuck at a rate near 10%, millions of people are about to lose their homes by foreclosure, and the American dream of owning a home has turned into a nightmare for many Americans.

This past Tuesday, August 2, 2011, ends one of the most outrageous episodes of legislative nonsense I can remember. Our government shot itself in the foot -- inflicting an injury upon our economy and our people that will take years to heal. Recent polls show that the public's faith in their government has reached an all time low. This feeling crosses party lines and includes virtually every group polled. The selfish and self-serving behavior of too many of our so-called legislators is disgusting.

What in the past made America a great country was that the people believed in democracy and enjoyed the benefits of being free as a direct result of our democratic form of government. Hopefully, it will sink into the heads of voters of all persuasions that we want and need an effective government. Then we will wake up and through the power of the vote put into office people who will once again make our government function.

Having gotten that off my chest, let's examine what this Budget Control Act of 2011 did for housing and us real estate professionals. To answer this question, you need to look at the actual bill. Here is the URL:

You will see that the bill is just 74 pages and if you look carefully you will see at the top that there is a search function. Try it out by typing in the word "budget" and see what happens. The result is that it appears 35 times, and each time is shaded yellow. Now try "Housing". Guess what? The word "Housing" does not appear anywhere in the 74 pages. Try "mortgage". Same result. Try "foreclosure". Struck out again. No results for "taxes" either.

The bottom line is that the government officials -- the President, the House and the Senate -- continue to ignore the best way to jump start the economy and create millions of jobs: fix up all the foreclosed houses and sell or rent them.

I invite you (if you haven't already done so) to read my
Editorial in the June 2011 Issue of REV, entitled "Economics: How to Solve Housing Market Chaos & Help Relieve Unemployment." [Click on the highlighted word "Editorial" at the top of this paragraph to go there.]



Economics: How to Solve Housing Market Chaos
& Help Relieve Unemployment

It is easy to become depressed when you follow the news these days.Unemployment seems to be stuck at a rate near 10%, millions of people are about to lose their homes by foreclosure, and the American dream of owning a home has turned into a nightmare for many Americans.

I keep hoping that I will hear that President Obama and the Congress are taking steps to solve the problem but so far not much is happening.

Many of us lived through the market crash and accompanying collapse of the housing market in the middle 1980s. If they think like I do, these folks feel that history is repeating itself. Back then, about 1,000 Savings and Loans went out of business and the press predicted that bailout would cost taxpayers $500 billion dollars.

What actually happened was that Congress passed the Financial Institutions Reform Recovery and Enforcement Act (FIRREA) enacted in 1989. Appraisers remember FIRREA because it required that real estate appraisers be licensed or certified. Prior to the Act, this was not the case. Each state had its own rules. FIRREA legislation was also responsible for the creation of the Appraisal Foundation and the Appraisal Subcommittee.

Far more importantly, it established the Resolution Trust Corporation which was given the responsibility to solve the housing mess. The RTC did so at far less than the predicted $500 billion dollar figure.

The glut of foreclosed houses is depressing the housing market and at the same time, there are legions of unemployed contraction workers who lost their jobs when the construction of new houses basically ground to a halt in 2008 and 2009.


Who's Against the UAD? (Who's For It?) Stay Tuned...

Two important letters have been written to the General Counsel of the Federal Housing Finance Agency (FHFA) which is the government agency current in charge of Fannie Mae and Freddie Mac because of their dire financial condition. Both of these letters are critical of the UAD and its proposed implementation. One letter is from Ami Mine-Allen, President of the Association of Appraisal Regulatory Officials (AARO). The other is from J. Carl Schultz, Chair of the Appraisal Standards Board (ASB) of the Appraisal Foundation.

It always surprises me how many appraisers are confused about the functions of the Appraisal Foundation, the State Real Estate Appraisal Commissions and their regulatory officials. The Appraisal Foundations creates the standards (USPAP), but has no authority or mechanism to enforce them. The individual state Real Estate Appraisal Commissions and their regulatory officials grant licenses and certifications, and are in charge of enforcing the USPAP along with their "state specific" regulations.


Follow-Up on Editorial: Do We Still Need Fannie Mae and Freddie Mac?

In my Editorial in the Fall 2010 online issue of Real Estate Valuation Magazine, I addressed the issue of whether we still need Fannie Mae and Freddie Mac. I offered some solutions as to what I felt would be a prudent solution to Fannie and Freddie's future.

This week, President Obama released the Administration’s plan for dealing with Freddie and Fannie in the context of the entire home mortgage market, entitled “Reforming America’s Housing Finance Market – A Report to Congress, February 2011."

Some of the report's major recommendations include:

  • Winding down Fannie and Freddie to a revised role in the mortgage market
  • Implementing immediate improvements to mortgage servicing and foreclosure processing by establishing national standards for both activities
  • Setting goals and targets to reduce the FHA's role in new mortgage production.
  • Reducing conforming loan limits.
  • Reducing the portfolio size of mortgages held by government housing finance agencies.
  • Increasing the required down payment to a minimum of 10% over a phase-in period.
  • Raising insurance premiums for government guarantees on mortgage products.
  • Returning FHA to its traditional role as the target lender of affordable mortgages.
  • Using the Consumer Financial Protection Bureau (CFPB) to empower consumers to make better informed decisions and avoid unfair lending practices.
  • Reforming the securitization market for home financing by increasing its regulation and monitoring.
  • Reforming servicing compensation and mortgages to eliminate the differences between first and second mortgages.
  • Revising goals and practices for how affordable housing and rentals will be supported by the government.

This is an overview of the Administration’s plan, which must be passed by Congress before it can be implemented. It affects the well being of some of the most powerful corporations and other interests in the country, represented by very powerful lobbies. In addition, the views of the political parties are very far apart on what needs to be done. This plan is just the first step in what is going to be a long and hard battle in Congress.

The entire Obama proposal (31 pages), which is summarized in this article, can be downloaded by clicking here.

My editorial containing some different ideas about what should be done is available in the Fall 2010 REV Magazine, downloadable at: http://www.revmag.com/downloads



Are the Big Banks REALLY Too Big to Be Allowed to Fail?

The public relations firms of the big banks in the United States and England are busily grinding out PR releases, trying to convince us that they are critical to reducing unemployment and jump starting our economy. It reminds me of the old joke about the person who murdered his parents telling the judge to show mercy because he is an orphan!

There are many institutions who shared in the creation of the economic mess we are now in, that directly affects appraisers and impacts the future of our profession. My nomination for the top of the list of miscreants are the "big banks." Admittedly, they had lots of company in enabling the housing market implosion, but without their profligate involvement, the subprime mess might have been avoided. The resulting foreclosures and the continuing slow recovery, as well as the malignant unemployment problem, are directly linked to their greed and disregard of everyone’s economic well being — except their own, of course...

Lurid tales of big bank foreclosure shenanigans are being reported in the press regularly. Judges all over the country are up in arms about the careless and often fraudulent papers presented to the courts in many foreclosure actions.I think we are just beginning to learn the true scope of the big banks' financial problems. The four largest banks in the US are Bank of America, CityGroup, JP Morgan and Wells Fargo. Gretchen Morgenson, a financial reporter for the NY Times, writes that these four banks have already set up reserves of about $10 billion dollars for possible mortgage repurchases. However, this may just be a drop in the bucket, considering that $5 trillion in mortgage securities were issued from 2005 to 2007. I think their mortgage losses may be big enough to put one or more of them out of business, and they still have to cope with gigantic credit card losses that haven't really been dealt with yet.

When the Feds put Lehman Brothers out of their misery, we were told that the economy could not get along without them. However, we seem to be doing just fine, as evidenced by the size of the bonuses paid by the other investment bankers to their employees in 2010.

When we are told that one of our big banks will need to be bailed out with our money because they are "too big to be allowed to fail," we shouldn't believe them! We have no shortage of banks in the United States, and bailing them out of self-inflicted bad investments is another example of allowing financiers to gamble with our money, and suffer no ill consequences! It proved disastrous in the 1980s savings and loan scandal, when it cost depositors and investors over $160 billion dollars. It's time for Americans to recognize that "banker mentality" is all about short term profits and bonuses, rather than stability, sound underwriting and sensible lending parameters.
askhenryharrison@revmag.com


Editorial: Inflation is Coming, Inflation is Coming!

It is my opinion that we are going to have some inflation in the United States shortly, and that this will be a good thing for the economy — and especially good for real estate.

I believe inflation is the inevitable result of the monetary and fiscal policies of the past year and those projected for 2011. Budget deficits have been growing dramatically, in absolute terms and as a percentage of GDP, and for the most part up to now they have not been financed with newly printed money. Instead, the deficit has been financed primarily with Treasury Bonds sold to foreign investors (China being by far the largest).

By announcing its plan to inject $ 600 billion into the economy by buying up Treasury Bonds to support the recovery and boost prices, the Federal Reserve Bank has unleashed a near-certain inflation. Fed Chairman Ben Bernanke has reiterated that the Fed is prepared to buy even more Treasury bonds over the next eight months, to continue the "economic easing" he began last month.

The simple fact is that this amounts to the Fed printing $600 billion dollars of paper money. Anyone who has taken an economics course knows that printing paper money causes inflation. That said, a modest inflation should be welcomed by those in the real estate industry.

“...a modest inflation should be welcomed
by those in the real estate industry."

A reasonable rate of inflation is good for real estate. The magic of real estate has historically been that you could invest in real estate (a home or investment property) with a small down payment, and borrow the balance with a long-term mortgage. Wise investors know that the mortgage must be at a fixed interest rate. Then, if inflation occurs (as it has for many decades), the investment appreciates in value.

Here is an example of how the magic of real estate investments works when there is a reasonable amount of inflation. Say the purchase price of a property is $300,000. The buyer puts down 10% of the purchase price, or $30,000. They get a mortgage on the remaining $270,000. In this example, the cash investment was $30,000. If there is an inflation of 3% a year, in just 5 years the property will be worth $345,000 ($300,000 x 115%) and the investor will have made $45,000 -- a 150% return on their initial $30,000 investment.

Of course this example is an over simplification, as it does not consider many other factors that may affect the value of the property, but it does explain why real estate has been a great investment when a small but reliable rate of inflation is operating in the economy.

Psychologically, moderate inflation stimulates spending, and lowers the real cost of paying off long term debt (you can pay off your mortgage using inflated dollars which are of lower value).

A nicely timed moderate inflation is, in my opinion, what will get us out of this slump! Hats off to Ben. I think he's made the right decision at the right time.