FHFA Director Lockhart’s Twisted Fannie Freddie Logic

I might have spoken to quickly on some items in my last post, “Fannie and Freddie Shareholders Benefit more than Homeowners.” I assumed that mortgage insurance would be required in President Obama’s Fannie Mae (FMN) Freddie Mac (FRE) 105% LTV refinancing scheme. FHFA Director Lockhart’s letter to the Mortgage Insurance Companies of America dated February 20 set me straight on that PMI will not be an absolute requirement for LTV over 80%. Lockhart wrote: “In layman's terms, the refinance initiative is akin to a loan modification for charter purposes as it affects loans for which an Enterprise already holds the credit risk.” Given Lockhart’s modification versus refinance theme, I don’t know if the GSEs would actual collect new loan initiation fees either.

The Dow Jones Newswires explains: “The government charters for Fannie and Freddie expressly prohibit them from guaranteeing or buying mortgages with loan-to-value ratios above 80% unless the borrower has mortgage insurance or the loan originator retains 10% of the default risk.”

While Lockhart considers the word refinance only a technicality and plans to circumvent the GSE charters, he does ask the PMI providers to indulge him in transferring any existing mortgage insurance from the original loans to the new loans at the same dollar amount. The credit enhancers are of course free to raise their insurance to a high dollar amount and provide PMI where it was not required in the original loans. The cooperation of PMI appears to be voluntary: “For that, the Enterprises and the homeowners need the assistance of the mortgage insurer. Thus it would be beneficial to the success of this initiative for mortgage insurers to work with both companies [Fannie and Freddie] as they move towards implementation.”

Lockhart’s logic is twisted. If the new loans lose PMI and no new origination fees are collected, the GSE risk does increase, even if their insured loan principal balances do not. Either the loans are refinanced or their not. Please help me understand the legal basis for Lockhart’s hybrid. Refinancing pays off the old loans and frees the borrower from the modification restrictions of mortgage investors. Conversely, loan modifications subject Fannie and Freddie to mortgage investor insurance claims.

Lockhart wants to refinance his way out of MBS insurance claims and modify his way out of the GSE charter obligations. This is the start of a bad precedent and interferes with the return of the GSEs to sound footing. If the PMIs don’t cooperate, and there is no reason why they should, the new mortgages become per social giveaways. What’s next, 100% mortgages for all?

No wonder Bloomberg is reporting “Fannie Mae Rescue Hindered as Asians Seek Guarantee.” The "Treasury’s Elusive Guarantee of Fannie/Freddie Debt and MBS" continues to be a recurring theme with foreign investors. The evasion of the GSE charters is just another reason why.

Disclosures: Author is long FNM and FRE.

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