New Rules At Fannie Mae Rules Combat Appraisal Fraud

Before we get to "New Rules" let's recap some recent news on Fannie Mae. There is a lot on news to digest. Let' start with Fannie Posts $3.6 Billion Loss in Fourth Quarter.

Fannie Mae said Wednesday that it lost $3.6 billion during the fourth quarter as credit conditions took a large toll on the government-sponsored enterprise. The quarterly loss pushed Fannie to a $2.1 billion loss, or $2.63/share, for the full year.

Earnings woes at the largest GSE were driven primarily by mark-to-market activity on derivatives holdings, leading to $3.2 billion in write-downs; Fannie also absorbed a $2 billion charge in building its credit loss reserves and an additional $600 million in impairment losses on mortgages and investments it moved into its held-for-sale portfolio.

Systemic Risk At Fannie Mae

Fannie Mae and Freddie Mack derivatives are a ticking time bomb. Untangling derivatives took Fannie years and clearly Fannie is still struggling with their hedge book as it is.

Fannie Rewarded For Poor Performance

In spite of the above, Fannie, Freddie Portfolio Caps Lifted.

Fannie Mae and Freddie Mac, the two largest financiers for the U.S. mortgage market, will see their portfolio growth caps removed as of March 1, 2008.

According to a statement released Wednesday by the Office of Federal Housing Enterprise Oversight, which regulates both GSEs and had imposed the portfolio restrictions in response to massive accounting errors, the move comes as “recognition of the progress being made by both companies, as indicated by the timely release of their 2007 audited financial statements.”

Lockhart also signaled that it may ease capital requirements at the GSEs. A current Consent Order requires Fannie and Freddie to maintain a capital level at least 30 percent above the statutory minimum, the result of financial and operational uncertainties associated with past accounting problems.

OFHEO will likely look to gradually decrease the 30 percent requirement in the months ahead, Lockhart said.

Shares in Fannie and Freddie surged on the announcement. Fannie Mae shares were up 10 percent to $29.68 in heavy trading on the New York Stock Exchange Wednesday morning, while Freddie Mac saw its shares jump 7.5 percent to $27.10.

Fannie clearly can't handle what it has already but what does OFEEO do? Eliminate lending caps, and consider easing capital requirements.

Does anyone remember the mission of the GSEs? It was to help make housing affordable. Has it come close to that mission? Clearly not. Make funds available to any idiot who can fog a mirror and the exact opposite will happen, which of course it did.

Fannie Mae and Freddie Mac, both should be eliminated for failing their mission. Instead, in the alternate Bizarro Universe we must be in, their loan limits will increase and capital requirements lowered. The market cheered as if this was good news. It wasn't. It increases the chance of a huge taxpayer bailout down the road.

Ironically, these caps removal are not going to solve their intended short term mission of increasing liquidity in mortgages, especially in regards to refis. Most loans originated in the past few years are now under water. Fannie Mae will not be refinancing those loans. In addition, Fannie has increased down payment requirements and has restrictions in high risk areas (essentially the entire state of California for starters) so there are still huge roadblocks still in place that are affecting the housing markets. Will some new loans get approved? Yes, enough to unjam the roadblock? No.

New Rules Prohibit In-House Appraisers

In an attempt to reduce appraisal fraud, Fannie Mae working with New York Attorney General Andrew Cuomo, is about to tighten the reins on appraisals. Bloomberg has the story in Fannie Proposes Ban on Lenders' In-House Appraisers.

Fannie Mae, the biggest source of financing for U.S. home loans, told lenders it will probably ban their use of appraisals by in-house employees or those arranged by brokers.

Fannie Mae distributed the proposal, a response to New York Attorney General Andrew Cuomo's yearlong mortgage probe, to lenders in a "talking points" memo this week, according to a person familiar with the document. The memo was published on American Banker's Web site yesterday.

"It would be a monumental change because it would require a shift in the way that the lending industry does business," said Jonathan Miller, chief executive officer of Manhattan-based appraisal company Miller Samuel Inc. and a longtime proponent of creating a firewall between residential appraisers and mortgage originators. "I think it would be tremendous."

The restrictions would apply to loans acquired after Sept. 1, according to the memo. Fannie also told lenders that an independent appraisal clearinghouse likely would be established.

`Laughable' Practice

About three quarters of residential mortgage appraisals are arranged through brokers who only get paid if a loan closes, Miller said today in a phone interview. He called the practice "laughable" because it creates a financial incentive for mortgage brokers to push appraisers toward higher valuations. Higher appraisals also mean more homeowners qualify to refinance their homes and take cash out, he said.

Gravy Train Of Appraisal Fraud Slows

I welcome this development. It will slow down, but not put an end to the fraudulent practice of deliberately appraising as high as necessary to get the deal done. Not only will Fannie refuse to accept in house appraisals, independents who deliberately appraise high run the risk of being banned by Fannie Mae.

Tanta on Calculated Risk's Blog has more analysis of this situation. Inquiring minds may wish to take a look. This is a very significant, and welcome change in the way GSEs will do business.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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