The FHFA should start working now to alleviate mortgage lock-in in future cycles

HousingWire recently published an op-ed advocating for FHFA’s Bill Pulte to make Fannie and Freddie’s (the GSE’s) mortgages retroactive. The intention is noble – most mortgage lenders are indeed trapped by low interest rates of the pandemic, draining liquidity from the housing market and preventing these borrowers from moving when they should. The reality is more complicated: This one-time solution is very difficult to implement, could potentially cost MBS investors hundreds of billions, and could make GSE IPOs unfeasible. Instead, FHFA should lay the groundwork so that we don’t have to have this conversation next time.

The FHA’s presumptive mortgages are presented as a possible solution to the current interest rate lock-in – a qualified buyer can take over the seller’s (low interest) mortgage at the seller’s current interest rate. However, there are reasons why FHA assumptions are made virtually non-existent despite the interest rate differences. It may be difficult for the seller to sell the home for a higher price because of the assumable mortgage, since the appraised value of the home does not take into account the mortgage’s assumability – so the assumability may not alleviate the seller’s lock-in (unless the seller also happens to find a mortgage to assume). Unless the buyer has sufficient cash on hand, they may also have to take out a significant second mortgage (at a much higher interest rate) to supplement the assumed mortgage, as the seller has likely already paid off at least some of the principal – significantly complicating the already complex process for first-time homebuyers.

Meanwhile, MBS investors – who provide trillions in liquidity and hedge interest rate risk for the GSEs – have already suffered significant losses in recent years (likely over a trillion dollars in unrealized losses) by holding pandemic MBS that currently pay much lower interest than short-term Treasuries. Retroactively underwriting GSE mortgages in a way that would actually help borrowers will further reduce the rate at which these MBS are predated, significantly increasing losses for MBS investors. Investors will look to widen the spread between long-term government bond rates and MBS (rising mortgage rates) rates – to take into account both the new conditions and increased uncertainty about what else could change. Furthermore, the MBS investors would take action by suing the GSEs to recover these additional losses, which could amount to more than the combined GSE profits of the past decade – entirely jeopardizing the future of the GSEs, potentially requiring another highly unpopular bailout, and destroying any hope of a successful IPO, with lawsuits likely to drag on for years. In addition, the largest MBS investor is the Federal Reserve (through quantitative easing) – effectively making taxpayers responsible for hundreds of billions in losses, even before lawsuits and bailouts.

Instead, the FHFA should consider how to solve the lock-in problem in the future – so that next time we don’t have to mourn being late again. Perhaps the FHFA could come up with an ingenious way to circumvent the implementation problems of deemed loans by restructuring various contractual provisions in the future.

They should also help drive the development of the second lien market, to enable borrowers to bridge the gap between the current loan and the value of the property. Alternatively, the FHFA could issue a (portable) mortgage that the borrower can take with them to their next home (as long as the LTV isn’t higher or the borrower makes an additional down payment), which by design alleviates seller lock-in (even for borrowers who are struggling because they don’t have to requalify), doesn’t have the same appraisal issues as assumed mortgages, and reduces the number of new loans a borrower goes through (since borrowers don’t have to take out new loans when they move, but simply get an appraisal or a AVM valuation).

However, transferable mortgages are not a panacea either: borrowers who trade up would need more cash or second liens, interest rates will likely be slightly higher, and giving borrowers options would reduce liquidity in the TBA market. In short, there are promising opportunities, and any FHFA RFI on this topic would certainly generate many informed responses.

Federal, state, and local governments could obviously do more to alleviate current pressures on housing costs. Particularly both removing various local zoning restrictions to allow for an abundance housing supply and reducing the accumulation of long-term budget deficits would make housing more affordable without endangering the entire mortgage system.

Alexei Alexandrov is a Ph.D. economist, who worked on mortgages and housing as a senior economist and artificial intelligence fellow at the Consumer Financial Protection Bureau and as chief economist at the Federal Housing Finance Agency.
This column does not necessarily reflect the opinion of HousingWire’s editorial staff and its owners. To contact the editor responsible for this piece: [email protected].

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