Friday, April 24, 2009

Fannie Mae Creates Housing Mirage With Bum Loans

Posted on Bloomberg by David Reilly:

Give money away. That was a solution to the housing crisis mortgage giant Fannie Mae hit on last year.

Faced with growing numbers of homeowners unable to make mortgage payments, Fannie decided to fund loans to borrowers that were instant losers.

The point was to buy time. Even though those loans resulted in a $453 million loss, they helped keep troubled homeowners from defaulting. That meant Fannie for now didn’t have to make good on loan guarantees that may have cost it as much as $2.4 billion.

The big game of kick the can strikes at a deep-seated fear among many investors -- that banks and others faced with mounting housing losses are finding all manner of dubious ways to push a day of reckoning into the future.

If that’s the case, any improvement in the housing outlook might be a mirage obscuring even greater pressures building in the financial system. That would eventually counter better-than- expected first-quarter results from many banks.

Investor angst was made worse by the knowledge that the government is leaning hard on banks to modify troubled loans any way they can. Prevent foreclosures and worry about the consequences later is the mantra of the day.

In a perverse way, there is some logic to such maneuvers. Today’s troubled borrower may be in better shape if given time to wait for fractured markets to heal. Or, if today’s losses can’t be cured, the company facing them may be better able to deal with them at a less-stressed future date.

Big Gamble

Still, that’s a big gamble. Markets may not rebound as quickly as some investors expect, meaning time might not heal the wounds of borrowers who can’t meet payments today. That would leave them in even worse shape in the future. And by failing to deal with problems now, financial institutions may cause them to grow even bigger.

That’s sure to lead to nasty surprises down the road at individual banks. It also promises to lengthen the economic slump by preventing markets from finding natural bottoms that allow excess inventory to be sold.

Fannie’s program shows how potentially big losses are still festering within the system, unbeknownst to investors.

Known as the “HomeSaver Advance” plan, Fannie used the program to provide “foreclosure prevention assistance to distressed borrowers,” according to its 2008 securities filing.

The plan entailed Fannie funding loans to help distressed borrowers get current on their mortgage payments. Fannie said there were about 71,000 advances made in 2008 with an average value of $6,500.

Really Thinking

Fannie funded $462 million in such loans during 2008. The company tells investors in notes to its financial statements, though, what it thinks the loans are actually worth.

Based on market prices, Fannie said the loans had a value of just $8 million. That’s right, the loans, which are in many cases just months old, were worth 1.7 cents on the dollar.

In a footnote, Fannie said there were several reasons for the huge markdown. Among them: the loans aren’t secured by any collateral; and they are second loans, or liens, that serve as catch-up payments for borrowers who can’t pay their primary debt.

This is reminiscent of the piggyback loans given out during the housing bubble to home buyers unable to come up with the usual 20 percent down needed to buy a house. Deals like those led to big losses.

Reality Intrudes

Granted, the HomeSaver Advance program isn’t a general loan modification program. It’s targeted at people who were current on payments and due to a big event like a divorce or loss of a job fell behind. The loans are meant to get them over that hump.

Still, these borrowers are probably at greater risk of future financial problems. And if Fannie wasn’t able to get them current, it could face even bigger losses. Because it has guaranteed the mortgages, Fannie would have to repurchase them at their full value in the event of a default.

After doing that, Fannie would have to work the mortgage out, likely selling the home, to recoup value. Because of the housing crunch, such recovery values slumped during 2008.

Fannie’s loss on such repurchases rose to 56 percent by year’s end from 40 percent at the start of 2008, its filing shows. For the year, the loss averaged 49 percent.

Based on this average loss, and using an average mortgage value of $175,000, Fannie would face a loss of about $2.4 billion if it had to repurchase the 71,000 loans covered by the HomeSaver program.

Not to mention that having to process 71,000 additional foreclosures might further depress real estate prices, driving Fannie’s recovery rates even lower.

Be that as it may, Fannie’s sobering writedown of these loans shows that even it knows the program may be an exercise in futility. The likelihood is many of these loans will go bad anyway.

The housing market will have to deal with that one day. In the meantime, Fannie is simply burning taxpayer dollars to create a housing smoke-screen.

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