August 28, 2010
The Great State of Texas experienced its real estate bubble in the 1980’s as a direct result of the U.S. Congress loosening lending regulations for Savings & Loans to irresponsible levels. This created the Savings & Loan debacle, the bubble burst, then the Resolution Trust Corporation’s “fix” nearly destroyed the Texas economy.
However, Texas emerged with a much stronger and more diversified economy (technology, healthcare, bio-tech, etc.) and more conservative banking practices.
In 1995, Congress and HUD began requiring Fannie Mae and Freddie Mac to start purchasing Sub-Prime mortgages under the guise of ”affordable” or “special affordable” loans made to low income borrowers. The terms and underwriting criteria of Sub-Prime loans violate every tenet of responsible risk assessment and underwriting philosophy ever developed by Fannie Mae and Freddie Mac. Sub-Prime loan terms are predatory in nature and are designed to punish the borrower for having bad credit.
Congress and HUD continued requiring Fannie and Freddie to expand their purchases of Sub-Prime securities through 2007. In 2004 alone, Fannie and Freddie purchased $175 billion of Sub-Prime loans, and an additional $1 trillion between 2005 and 2007. (Source: HR 1728, pgs. 208 – 211)
The prolific expansion of easy mortgage credit from 2003 through 2007 created real estate bubbles primarily concentrated in four states – California, Nevada, Arizona, and Florida.
When the high rate of Sub-Prime and Alt-A (stated income, no doc, etc.) defaults became apparent, the market value for these securities collapsed. This collapse created a systemic liquidity crisis which, in turn, created the current economic crisis. All financial firms that had invested in Sub-Prime and Alt-A securities, including Fannie and Freddie, became (or nearly became) insolvent.
Because Texas had learned its lesson in the ‘80’s and has not had any notable real estate bubbles since then, we appeared to be well positioned to weather the storm. However, because the national system for mortgage credit has tightened dramatically and the non-conforming (Jumbo) mortgage market has nearly vanished, Texas has been negatively affected by the national crisis. Our higher-end market has been especially decimated due to the lack of available financing. Our continued dependence on federal sources for mortgage financing will undoubtedly continue to negatively affect our state well into the future.
With Congress talking about shrinking or possibly eliminating Fannie Mae and Freddie Mac, Texas and Texans would be wise to consider forming a secondary mortgage market institution to ensure the availability and affordability of mortgage financing for Texans in the future. This institution should serve as a secondary mortgage market conduit exclusively for Texas real estate financing.
The State of Texas has a world class lender and appraiser licensing and regulation system. The State of Texas also has several established agencies that can advise, contribute to, and regulate such an institution. Texas has an abundance of intelligent, talented, experienced, and ethical mortgage professionals. Texas also has an abundance of wealthy individuals and corporations who would be eager to invest in such a company and its securities. If measured as a country, our state economy ranks as the 15th largest in the world. Our residential real estate market is averaging $40 billion in sales per year. With so many of the necessary ingredients already in place, we have the opportunity to show the world how to do something truly special.
The following are suggested parameters for the structure of the institution:
• A public/private joint venture would likely be best to assure investors of the reliability and sustainability of the institution and its mortgage-backed securities. If structured properly, the institution could be a substantial revenue stream for the State.
• The company should employ best practices for mortgage lending, mortgage banking, risk assessment, and securitization. Initial funding could come from the State as well as state and local banks and credit unions. If the State has an ownership interest, it should never exceed 49%. The Texas Legislature should be expressly prohibited from requiring the company to purchase or create any loan products that do not represent sound, conservative terms and guidelines (i.e. no Sub-Prime or Alt-A products).
• The company should be structured to ensure long-term profitability. Mortgage insurance should be required on any loans that exceed 80% of a property’s value to protect lenders from default losses. A fee should be incorporated into the pricing of each loan and/or pools of securities to protect investors from the loss of their investment capital. This feature will generate higher prices and lower interest rates for the securities.
• Part of the company’s mission should be to develop and implement programs to inform and educate Texans on responsible financial management (becoming financially self-sufficient, growing wealthy over time, and giving back), with special emphasis on home ownership and the wealth building aspects of Texas Real Estate. This will help ensure we have qualified home buyers for generations to come.
• Loan programs should have conservative but flexible terms. Risk based pricing tied to credit scores and loan-to-value ratios should be a component. For borrowers starting with weaker credit scores and higher interest rates, a rate reduction feature should be available to award the borrowers for timely mortgage payments, similar to Fannie Mae’s former Timely Payment Rewards program.
• Since everything is bigger in Texas, the Texas Conforming loan amounts should be:
95% LTV to $425,000
` 90% LTV to $650,000
80% LTV to $750,000
70% LYV to $1,000,000
These parameters would breathe new life into the upper end of our markets.
• Underwriting guidelines can be a combination of Fannie/Freddie guides and common sense, portfolio style guidelines specifically tailored for Texas.
These are but a few suggestions for the shape of a Texas secondary mortgage market institution. The purpose of this proposal is to start a dialogue among Texans to determine if this is something we want and need to create. Because our legislature will be in session in a few months and is only in session every other year, and since it’s possible the State of Texas may be a principal party to the creation of such an institution, it’s imperative that we have something in place for the legislature to consider as soon as possible. Waiting until 2013 may be too late.
I encourage all of you to provide feedback by joining the Austin Mortgage Network group at LinkedIn.com. Let’s circle the wagons, grab the bull by the horns, and figure out the best way to put together an entity for Texas, by Texans.
Sincerely,
Rick Baron
512-422-1949
rick@rickbaron.com
Good info!