In the six months since the Federal Housing Finance Agency and the GSEs announced the return to low down payment mortgages, with Fannie Mae CEO Tim Mayopoulos noting, “Now we can safely and responsibly do these loans,” the industry and its followers have been in debate on the prudence of GSE re-entry into high loan-to-value lending.
Given recent history, that’s an understandable response from the general public and some mortgage lending stakeholders. However, the practically Pavlovian fear and loathing triggered by the phrase “97% LTV” is overblown.
Seasoned mortgage veterans of several boom-bust cycles know that borrower creditworthiness and dependable collateral valuation are the benchmarks of a responsible mortgage. When these attributes are eroded or systemically overlooked, any loan product can go rogue. Conversely, when healthy credit risk and collateral risk management assessments are in place, virtually any loan product can be properly originated within accepted risk thresholds at appropriate pricing.
Perhaps it has been too easy to forget why the mortgage market did not merely experience a correction in 2008, but instead contributed to a global economic derailment. The reasons had little to do with oft-referenced subprime mortgage products. The true culprits were turning a blind eye to historically sound practices for credit underwriting as well as systemic disconnects in collateral assessment and valuation methodology. Flaws in the fundamentals — safe and sound credit and collateral risk management processes — meant not only devastating numbers of mortgages defaulting, but credit losses that shook Wall Street and forced the GSEs into conservatorship.
If we are honest with ourselves, it was never really a surprise but simply a matter of time. Human nature tends to look for excuses that lie within the system as opposed to taking a hard look in the mirror and owning our own mistakes or misdeeds.
The silver lining of the market crash was a unique opportunity for non-legislative reform that would not have otherwise come to bear. When the GSEs entered conservatorship in to 2008, it was with a firm directive to reconstruct their respective and shared infrastructures in such a way that the mortgage industry could and would be compelled to adapt its practices. The secondary market needed a mechanism to determine for itself whether underwriting best practices and requirements were being met — before the loan was accepted into the secondary markets. The GSEs prioritized the development of the Uniform Appraisal Dataset and the creation of the Uniform Collateral Data Portal, followed by Fannie Mae’s launch of Collateral Underwriter this year, partly as triage — treating the greatest infrastructure-related risk first. As with any asset-based lending, the mortgage finance system must at a minimum support the reliable and consistent value determination of the underlying asset. Accomplishing that meant creating both a standard vocabulary for appraisals and a shared platform for their transmittal to ensure the standard was being met, enabling the transparency required for reliable and accurate collateral valuation.
Prioritizing the collateral valuation component also had to do with planning for a more robust investor environment not so heavily reliant on the GSEs (a subject often discussed early by the FHFA). Again, there is a credit risk side to the investment risk calculus, but more significant and pertinent to the re-emergence of private label investment is the risk of inaccurate and unreliable loan data — specifically relating to the underlying value of the loan collateral.
Understanding the return of 97% LTV programs means realizing that the industry is succeeding, through significant non-legislative reform and productive public-private partnerships, in curing its most egregious risks — such as those related to collateral valuation. It is now a proven model that has been very successful. The GSEs’ comfort with low down-payment lending is a reflection of its confidence in obtaining a clear and early understanding on the value side of the loan-to-value equation.
FHFA and the GSEs are similarly tackling other aspects of the loan file with other initiatives under the Uniform Mortgage Data Program, such as the Uniform Closing Dataset, for even greater transparency. If the continued call for greater private market participation is to be realized, those stakeholders will need to embrace the same or similar approach. Anything less virtually guarantees a return to the same practices that drove the markets into a downward spiral.
With GSE confidence and empirical evidence showing that mortgage finance does not have to be risky business mortgage lenders can look forward to product diversification and whetted investor appetite for residential mortgage-backed securities. In that context, I would hope we can agree that a return the 97% LTV lending is a positive development.