Belated Withdrawal From Risk

From the New York Times

Saturday August 16, 2008


FLOYD NORRIS
Published: August 14, 2008

Sometimes what appears to be best for every individual is bad for the group. Now is such a time in the banking business.

Banks that took foolish risks in the mortgage business now want to take no risks at all. A similar risk aversion is growing at Fannie Mae and Freddie Mac, the two government-sponsored enterprises — perhaps government-guaranteed enterprises would now be a more accurate description — that dominate the mortgage market.

JPMorgan Chase started the latest downdraft in bank share prices this week when it said in a filing with the Securities and Exchange Commission that it expected a lot more losses before the mortgage situation stabilized.

And what will it do about that? “In response to continued weakness in housing markets,” it told the S.E.C., “loan underwriting and account management criteria have been tightened, with a particular focus on M.S.A.’s with the most significant housing price declines.”
M.S.A.’s, for those of you not up on the jargon, are “metropolitan statistical areas,” which means areas like Los Angeles and Las Vegas. JPMorgan said it would clamp down on auto loans and credit cards, as well as mortgages, in areas where home prices are falling.

That vow not to lend where the money is needed the most came a few days after Fannie Mae announced a strategy of selling foreclosed properties as rapidly as possible, and of trying to force banks to share some of its losses.

Daniel H. Mudd, Fannie’s chief executive, told investors that Fannie was “using a lot of innovative ways to get the property out the door.” This is not, he said, a good time to be holding on to foreclosed properties “and hoping for a better day.”

I’m not sure what those “innovative ways” were, but I suspect they involved price cutting. RadarLogic, a firm that monitors home sales, tries to separate out what it calls “motivated sales,” chiefly by looking at whether a bank or foreclosure service firm is the seller. It says that in hard-hit markets like Miami and Las Vegas, the motivated sale prices are about 25 percent lower than other sale prices.

Fannie and Freddie are trying to earn their way out of this mess by jacking up the fees they charge to banks for buying or guaranteeing loans. Their expected profit margin on new business is at the highest level in years, and borrowers who can get loans are paying higher rates as a result.

Fannie also vows to force banks to buy back defaulted loans if there is evidence of fraud or violations of procedures. Mr. Mudd said such recoveries were up fivefold, and he expected them to keep rising. Fannie also will stop buying so-called Alt-A loans, which are credit-score driven. Freddie says its portfolio of loans will not grow this year.

It is easy to understand why this is happening. A year ago, when Mr. Mudd had a similar conference call with investors, the mortgage crisis was just starting to mushroom, and he conceded Fannie would be hurt.

But he had no idea how much hurt there would be. “We fundamentally held our standards,” he said. Fannie lost market share in the wild days, but the loans it did make “remained Fannie Mae quality loans. So we feel pretty good about that.”

Those good feelings are gone. Fannie measures its credit losses in basis points — hundredths of a percentage point — of outstanding mortgages. A year ago, Mr. Mudd forecast an annual loss rate of 4 to 6 basis points, and scoffed when one questioner suggested the rate might rise to twice that level.

Fannie’s latest forecast for 2008, raised last week, is 23 to 26 basis points.
Foreclosures are soaring. In 2006, Fannie and Freddie between them acquired 52,967 properties, a figure that leaped 36 percent, to 71,961, in 2007. During the first half of this year, there were 66,420 foreclosures by Fannie and Freddie.

Not only are there more foreclosures, the losses are much larger. In 2005, Fannie lost an average of 7 percent of the unpaid principal when it sold a foreclosed property. So far this year, the figure is 26 percent, and in California it is up to 40 percent. In all of 2006, Fannie foreclosed on 93 California homes. The current rate is almost 1,000 a month.

In the year since Mr. Mudd claimed Fannie had held its standards high, both Fannie and Freddie shares have lost nearly 90 percent of their value. Freddie says it plans to raise $5.5 billion in new capital. With a current market capitalization of under $4 billion, that may not be easy.
Each bank is acting rationally. Financial institutions need to conserve capital, so they raise prices, tighten standards and sell foreclosed properties quickly. But when all do those reasonable things — which should have been done years ago — they deepen the crisis for homeowners, and for themselves.