I. Introduction
After the six year housing boom ended in the summer of 2006, home sales and prices have fallen dramatically.[1] Overall home sales in 2007 dropped 26.4% from 2006, making it the biggest drop since the Commerce Department began keeping track in 1963.[2] New home sales fell 18.1% in 2006 and by the end of 2007, sales dropped 56.5% from July 2005's peak home sales.[3] In 2007, new home sales dropped 26.4%: 32.2% in the West, 26.7% in the Midwest, and 26.3% in the South.[4] Aside from lacking sales, in areas like Las Vegas and San Diego, more than 40% of home sales in recent months were related to foreclosures.[5] Over the past couple of years, the number of forclosures increased, home building declined, the number of empty homes increased, and the domino effect is now spreading to other areas of consumer spending.[6] With a depressed housing market, many believe that changes in the financial and lending industry can help the market get back on track.
Fannie Mae and Freddie Mac, the two mortgage investment giants, have undergone many changes in the past few months. Many are relying on these regulatory changes to help ease the current housing crisis. Three major changes projected to have a positive impact on the housing market and other financial institutions are: the new appraisal rules, the lowered capital surplus requirement, and the the temporary increase in loan limits.[7]
II. Fannie Mae and Freddie Mac: What Do They Do?
Fannie Mae and Freddie Mac are the two biggest home mortgage investing companies in the United States.[8] The two government-sponsored enterprises (GSEs) are privately-owned corporations authorized to make loans and loan guarantees.[9] The two giants operate in American's secondary mortgage market to ensure that mortgage bankers and other lenders have enough funds to lend to home buyers at lower rates.[10] The GSEs purchase mortgages from lenders and hold some of the mortgages while others are securitized and sold in the form of securities.[11] Regardless of whether the borrower actually repays the loan, both companies guarantee that the principal and interest on the underlying loans will be repaid.[12] This ultimately means that when borrowers fail to repay their loans or foreclose their homes, the GSEs have to pay the investors and realize the loss.
III. New Independent Appraisal rules
Fannie Mae and Freddie Mac announced on March 3, 2008 that they would only buy mortgages from lenders that use independent appraisers.[13] The new appraisal rules for Fannie Mae and Freddie Mac, taking effect on January 1, 2009, is the end product of New York Attorney General Andrew Cuomo and his efforts to stop appraisal abuse.[14] The agreement between the GSEs and Attorney General Cuomo is the first step towards solving inflated home appraisals, which played an important role in the subprime mortgage crisis.[15]
Currently, there are no requirements for property appraisers to be independent from the mortgage broker or the lending company. Due to the lack of regulation on the type of appraisers one can use to valuate their property, many times banks or brokers will choose an appraiser for the customer.[16] These ties between lenders and appraisers are dangerous because the relationship creates an incentive for the appraisers to inflate the value of homes.[17] This kind of arrangement allows lenders to give larger loans to customers and then sell the loans to investoment firms, while appraisers can continue to get additional business through banks and brokers. [18]
Pursuant to the new rules, Fannie Mae and Freddie Mac will only buy loans from lenders that use independent appraisers.[19} More specifically, in-house appraisers cannot do the first valuation on a home, a subsidiary or an affiliated company of the lender or broker are forbidden from conducting an appraisal, and lenders, brokers, or real estate agents cannot pick appraisers for the customer.[20] Despite the disgruntled response from lending institutions and brokerage firms that argue the new regulations will put some out of business and create a competitive disadvantage for others, many supporters believe that the new appraisal rules will bring a positive change to the housing market.[21]
In addition, Fannie Mae and Freddie Mac will put up $24 million to create the Independent Valuation Protection Institute, a watchdog agency for the new regulations.[22] The mission of the institute is to implement the new appraisal rules and also work with the Office of Federal Housing Enterprise Oversight (OFHEO).[23] The institute will not only put the new appraisal rules in place, but the organization will also monitor the enforcement of the new rules, accept complaints from consumers and appraisers, and report to the regulators of Fannie Mae and Freddie Mac – Attorney General Cuomo's office and OFHEO.[24]
IV. Other Changes: Lowered Capital Requirement and Increase in Loan Size
Other additional changes are allowing Fannie Mae and Freddie Mac to further help the distressed housing market. First is the reduction in the capital surplus requirement. Due to the large losses Fannie Mae and Freddie Mac experienced in the last couple of years, the OFHEO required the mortgage giants to hold 30% more capital than the statutory requirement for risk-management purposes.[25] Earlier in March 2008, the Fannie Mae was concerned about maintaining the capital surplus requirement that the comapny was exploring the possibilities of reaching out to overseas investors in Asia and Europe.[26]
However, on March 19, 2008 OFHEO finally reduced the capital surplus requirement from 30% to 20%.[27] This reduction will free up to $3.2 billion for Fannie Mae and $2.6 billion for Freddie Mac in capital.[28] When this extra capital is freed, it will provide up to $200 billion in immediate liquidity to the mortgage-backed securities market, providing funds for home mortgages and other related securities.[29] Many believe that this increase in liquidity will provide more loans for consumers at lower rates, help the two million homeowners facing the risk of foreclosure in the next two years to refinance their loans now, and eventually assist in bringing the plummeting home sales and prices to a halt.[30]
The second change affecting the mortgage market is the new conforming loan limit. Now with the passage of the Bush administration's economic stimulus package, the GSEs and the Federal Housing Administration can temporarily purchase loans beyond the conventional loan limit.[31] With the exception of Alaska, Hawaii, Guam, and the U.S. virgin Islands, the cap on loans that the two GSEs can back have been temporarily increased from $417,000 to $729,750 until the end of 2008 for more than 70 U.S. counties.[32] This change will allow the GSEs to recharge the jumbo mortgage market that has been closed recently.[33] Since the credit crunch, many lenders have fallen into self-preservation mode, lenders have been preserving their cash to reduce risk instead of providing funding for jumbo loans.[34] The new temporary increase will not only help provide funding for larger loans, but it will also allow the GSEs to loosen up the higher end of the market where more wealth is concentrated and circulate that wealth to the market.[35]
V. Conclusion
The housing market has fallen into a deep slump over the past few years. Government agencies and investment firms are doing all they can to reduce the inflation of home appraisals, reduce interest rates, and reduce the risk of foreclosures to benefit consumers and lending institutions. The new appraisal rules may put some appraisal companies out of business and others in compromising situations; however, in the long run, it is a change that is needed to protect consumers, investors, and the overall market. In addition, with more liquidity available and larger jumbo loans able to be bought by the two GSEs, it seems as though the housing market is headed toward more stable grounds. Fannie Mae and Freddie Mac are the biggest buyers of American home mortgages and the regulatory changes have mostly been in hopes of breaking the cycle of the weakening housing market.[36] Because the two mortgage giants affect so many of the home loans in America, they essentially set a de facto industry standard; and hopefully these new standards can restore the integrity and the confidence in the mortgage market for investors and consumers.[37]
Sources:
[1] Vikas Bajaj, Housing, N.Y. TIMES, Dec. 27, 2007, available at http://topics.nytimes.com/top/reference/timestopics/subjects/h/housing/index.html?scp=1-spot&sq=&st=nyt
[2] Allan Lengel, New-Home Sales Fell Record 26 Last Year, WASHINGTON POST, Jan. 29, 2008, at D01, available at http://www.washingtonpost.com/wp-dyn/content/article/2008/01/28/AR2008012801017.html
[3] Martin Crutsinger, New Home Sales Took Record Fall in 2007, INTERNATIONAL BUSINESS TIMES, Jan. 28, 2008, available at http://www.ibtimes.com/articles/20080128/new-home-sales-took-record-fall-in-2007.htm
[4] James R. Hagerty and Kris Hudson, Wave of Foreclosure Drives Prices Lower, Lures Buyers, WALL STREET J., Mar. 25, 2008, at A1, available at http://online.wsj.com/article/SB120640573882561087.html?mod=googlenews_wsj
[5] Id.
[6] Bajaj, supra note 1.
[7] James R. Hagert and Amir Efrati, Fannie, Freddie Set Strict Appraisal Rules, WALL STREET J., Mar.4, 2008, at A3, available at http://online.wsj.com/article/SB120456185094007821.html; David Bogoslaw, Fannie and Freddie Set Free, BUSINESS WEEK, Mar. 20, 2008, available at http://www.businessweek.com/investor/content/mar2008/pi20080319_754797.htm?campaign_id=rss_daily&referer=sphere_related_content&referer=sphere_related_content; Sara Murray, Fannie, Freddie Loan Limits Raised For More Than 70 U.S. Counties, WALL STREET J., Mar 6, 2008, available at http://online.wsj.com/article/SB120482805379017059.html
[8] Fannie Mae, An Introduction to Fannie Mae, at 3, available at http://www.fanniemae.com/media/pdf/fannie_mae_introduction.pdf;jsessionid=UF4U4IX2LRFXLJ2FECHSFGA
[9] Id.
[10] Id.
[11] Id.
[12] Id.
[13] Hagerty and Efrati, supra note 7 at A3.
[14] Id.
[15] Vikas Bajaj, In Deal With Cuomo, Mortgage Giants Accept Appraisal Standards, N.Y. TIMES, Mar. 3, 2008, available at http://www.nytimes.com/2008/03/04/business/04loans.html?_r=2&oref=slogin&oref=slogin
[16] Hagerty and Efrati, supra note 7, at A3
[17] Id.
[18] Id.
[19] Bajaj, supra note 15.
[20] Id.
[21] Id.
[22] Id.
[23] Id.
[24] Id.
[25] Bogoslaw, supra note 7.
[26] James R. Hagerty and David Wessel, Fannie's CEO Visits Asia, Europe As Worries Grow, WALL STREET J., Mar. 10, 2008, at A2, available at http://online.wsj.com/article/SB120509431120122739.html
[27] Bogoslaw, supra note 7.
[28] Id.
[29] Id.
[30] Id.
[31] Murray, supra note 7.
[32] Id.
[33] Bogoslaw, supra note 7.
[34] Id.
[35] Id.
[36] Bajaj, supra note 15.
[37] Id.