The fine gentlemen at the Texas A&M Real Estate Center turned out to be a yellow light instead of a green or red light. They raised some valid questions about the project’s functionality and acceptability in the secondary market, and I had neither the time nor the connections to have properly addressed them by the time we met. They had also been working on their own national mortgage reform proposal for the previous three years and were about to present it to Congressional staffers, so it was not a good time for me to solicit their support.

Since the TX legislative session was nearing an end and my bank account was getting low, I decided the best strategy was to back off of the project, get back to work and make a little money, revise the strategy and set my sights on the next session in 2013. Governor Perry throwing his hat into the presidential ring has opened up some interesting possibilities since then, making it conceivable to be addressed sooner.

Trying to get the word out and gain support for this project via a written blog is a bit tedious for my taste. I believe it won’t get through to my target audience nearly as effectively as a brief but to the point video message. I’ve been wanting to try some video marketing for some time now anyway, so last May I bought a new computer that can capably handle hi-def video and I have been honing my skills on different software editing programs. My home office now doubles as a video studio, complete with professional lighting, a green screen and a white screen. If I’m going to do this, I want it to look good and be effective. If it comes together as planned I have several different projects it will work for in addition to this one.

In September I also managed to have lunch with a couple of seasoned, experienced capital markets and risk management gentlemen. They are experts in the secondary market. It was one of the most enjoyable experiences I have had in quite some time. They started out justifiably skeptical of the concept, but three hours later I had either worn them down or won them over, I’m not sure which. Either way, they graciously agreed to make a few phone calls and crunch a few numbers to see if such a concept could function effectively as proposed in the secondary market. They also said they would run it past some Wall Street folks at the national MBA Conference in Chicago this month, and I’m anxiously awaiting their feedback. It may not end up looking exactly like I outlined it, but my gut tells me the general concept will still work. It has its best chance if we can figure out a way for Fannie, Freddie and Wall Street to benefit from it somehow and show how it can be duplicated nationwide.

If they give me positive feedback indicating this concept is viable, I’m heading back to A&M to try again to gain their support. If I get their blessing this time, I have a good chance of gaining support from both TAR and TMBA to help lobby for its creation. I will also post a video or two to help sell the concept and spread the word as much as the internet will let me. I think I’ll be proficient enough to have something online sometime in November. Wish me luck. – rb

Description of Purpose – This is a proposal for the State of Texas to sponsor the creation of a 501(c)(3) Non-Profit Corporation (NPC) for the purpose of purchasing, securitizing and selling mortgage loans that meet its criteria to institutional investors in the Mortgage-Backed Securities (MBS) secondary market. Mortgage loans secured only by Texas properties will be purchased from state-wide mortgage lenders. It will be founded on the principle that the two most important parties in the flow of mortgage money are the borrower and the investor.

With tax exempt status and no need to distribute profits to shareholders and investors, the NPC substantially reduces and possibly eliminates the moral hazard of private profits and social losses in the mortgage securitization arena. The vast majority of its net operating revenues will be banked into an ever-growing Guaranty Reserve Fund (GRF), with a smaller percentage consistently added to operating capital to gradually reduce the need for financing of its operations. Also, at least 1% of its annual net operating revenue will be dedicated to public financial educations efforts to teach citizens how to become qualified, prime-class mortgage borrowers and home owners.

Since the Federal Government has announced the wind down of Fannie Mae and Freddie Mac over the next 5 to 7 years, and because they will be reducing maximum loan amounts, increasing down payment requirements, and raising fees between now and then, it only makes sense that we should create a securitization firm that protects the state from the additional harm this will cause to Texas real estate markets. Doing so will also have a positive impact on property tax and sales tax revenues, stabilize and support our real estate markets, support and strengthen our regional economy, and normalize our mortgage lending environment.

Description of Loan Products – Initially, loan products will mirror current Fannie Mae and Freddie Mac Agency products and securities with a few key differences outlined later in this document. Products allowed will be prime class fixed and adjustable rate terms ranging from 10 to 30 years in duration. Adjustable Rate Mortgages offered will be 3/1, 5/1 and 7/1 ARMs with 2/2/6 caps on 3/1 ARMs and 5/2/5 caps on 5/1 and 7/1 ARMs and indexed to 1 Year Treasury Securities. Loans will be secured by 1 to 4 family residential properties only. No loans will allow for negative amortization, pre-payment penalties, or interest only features. Multi-Family securitizations may be phased in at a later time if deemed appropriate.

Loan-to-Value ratios (LTV’s) and Combined Loan-to-Value ratios (CLTV’s) will be as follows:

Conforming SFR Owner-Occupied:

95% LTV to $417,000

90% CLTV to $417,000

90% LTV/CLTV to $417,000 on all ARMs

Second/Vacation Homes – 90% LTV

2-4 Unit Owner-Occupied and Investor loan limits will match current Fannie Mae limits

Investor (Non-owner occupied) – 80% LTV 1-2 Unit – 75% LTV 3-4 Unit

Jumbo Conforming SFR Owner Occupied:

90% LTV/CLTV to $625,500

All cash-out/equity loans will be limited to 80% LTV/CLTV

Eventually, a self-insuring, 3% down First Time Home Buyers program will be introduced to compete with FHA, and possibly a zero down VA-type program as well for Military Veterans.

All loans with LTV’s above 80% will require Private Mortgage Insurance (PMI) to assist in restoring investor losses in the event of default. Loan level price adjustments and risk-based pricing will also be used within reason. The above terms will remain the same as Fannie and Freddie wind down.

The Jumbo Conforming terms will possibly require Congressional approval since they are not currently allowed in Texas. However, the lack of available Jumbo financing has decimated Texas property values in the $500k to $1 million price range causing tremendous losses in property tax revenues. In Travis County alone, assessed values in this range fell by over $1.7 billion between 2009 and 2010 (source: TCAD). We desperately need affordable and available financing in this range.

Underwriting Philosophy – Technology has been a tremendous benefit to the mortgage industry. However, circa 2000-2001, a sea change occurred that caused the industry to lose its way. It was decided that software underwriting programs would make the final loan decision on all loans sold to Fannie Mae and Freddie Mac. This change removed human accountability for risk-assessment from the system and relegated human underwriters to the role of “validators” of the information required by the software. Sub-Prime and Alt-A lenders quickly followed suit, and before long the risk of default was all but disregarded. This shifted all of the risk of default and loss to the borrower and the investor while all of the “middle-men” benefitted immensely.

Software is a useful underwriting tool, but it can only assess numerical parameters set by its programmers. In the first 7 years of the past decade the parameters were clearly set too broadly and today the parameters are too narrow and inflexible. Software simply cannot properly assess a borrower’s risk of default as well as a human underwriter can, nor can it be held accountable for its results. Therefore, this institution will require that human underwriters have final loan decision responsibility for all loans, along with the authority to override software findings either pro or con with proper justification and documentation.

Borrower income, assets, credit history, debt-to-income ratios, and property appraisals will be required, documented and assessed on every loan by certified human underwriters. For the previous six decades before the last one, this method of underwriting worked extremely well and resulted in an historical default rate of less than 1%. Underwriting software will continue to be used but only as an underwriting aide.

This institution will be staffed with human underwriters with no less than 15 years of underwriting experience. Underwriters for state-wide lending institutions will be encouraged to call staff underwriters to discuss scenarios and gain assistance with loan decisions.

Underwriting Accountability – All loans will be tracked and monitored. Loans that default within the first 12 months will be flagged and analyzed for fraud, improper underwriting, and unforeseen circumstances. Where improper underwriting is determined, policies will be in place to put underwriters on probation and/or require decertification if certain default benchmarks are exceeded. Underwriters are much more prudent when they know their job is on the line.

100% Risk Retention – The FDIC recently released its joint recommendation with six other agencies requiring non-Qualified Residential Mortgage securitizers to retain 5% of the risk of loss on the MBS it sells. This institution will endeavor to retain 100% of the risk of loss on its securities, exceeding FDIC requirement by 95%. The NPC will retain specific authority to foreclose on defaulted properties on behalf of the investor. With PMI covering losses above 80% LTV, the vast majority of properties can be liquidated quickly at roughly 85% of their value, allowing the NPC to pay off the entire loan and recoup the costs of foreclosure. Once a property is foreclosed upon, the GRF will be used to bring delinquent payments current and will continue to make monthly payments to the investor until the property is liquidated and the loan is paid in full. Any deficiencies resulting from the liquidation of the property will be covered by the GRF as well. Any excess funds resulting from liquidation will be put back in the GRF.

100% Transparency – By law, a Non-Profit Corporation is required to be transparent in its operations in order to maintain its tax-exempt status. However, this institution will go much further on behalf of investors. It will provide an investor portal where interested investors can view real-time information on the level of its Guaranty Reserve Fund as well as delinquency and default rates, pre-payment speeds, and any other information deemed important to an investor’s decision whether to invest in this firm’s securities. This information will be easier to obtain and maintain if the sister non-profit servicer recommended below is also created.

Geographic Concentration of Risk- Although Texas is currently one of the healthiest real estate markets in the nation and has a large and diverse economy, geographic concentration of risk is still an issue for investors. However, mechanisms will be in place to help mitigate this risk such as increased down payment requirements in particular zip codes or MLS areas when bubbles are detected, and LTV increases to 90% for qualified investors to stimulate sales in areas that are depressed.

Securities and Securitization Volume – Securities offered will be of the simple “pass-through” variety and hopefully traded in the TBA and Specified Pool markets. Texas funds over $35 billion per year in mortgage loans (source: TMBA) and generates an average of $40 billion per year in residential real estate sales (source: Texas MLS). It is anticipated that this company will be able to securitize and sell between $10 billion and $30 billion per year in MBS.

The goal of this institution is to create securities of high enough quality and safety to compete effectively with U.S. Treasury Securities.

The Guaranty Reserve Fund – Assuming 1% gross revenues from delivery and guaranty fees and $12 billion per year in securitizations, this company should easily be able to set aside $100 million per year into its Guaranty Reserve Fund to protect investors from losses. Once the fund reaches appropriate levels as determined by actuaries, excess revenues can be used to increase operating capital and reduce the need for financing. Excess reserves will also be used to support affordable housing/financing goals such as down payment assistance programs and possibly interest rate subsidies.

The GRF will be self-funding from securitization operations and will grow stronger every year. Neither state nor federal taxpayer funds will be used or risked to protect investors.

Start-up and Operating Capital – To achieve the necessary economies of scale, it is estimated the NPC will need to raise $100 million in order to borrow up to $1 billion to finance initial securitization operations. Funds will be raised from industry participants such as Realtors, builders, mortgage professionals, financial institutions (community banks, credit unions, state banks, etc.), and possibly the State of Texas. I am currently researching commercial financing options and costs.

Legislation – State sponsorship is sought only to reassure investors this institution will be responsibly managed and regulated and to assist with start-up. Texas already has world-class licensing and regulatory infrastructures in place, so proper regulation and oversight is guaranteed. Additionally, carefully crafted legislation will be required (through Joint Resolution) to ensure lawmakers are prevented from accessing the GRF or requiring the NPC to lower its credit or lending standards. Industry participants need to clearly understand that the State of Texas will explicitly NOT guarantee this entity’s securities against losses. The NPC will provide an agency guarantee only.

501(c)(3) Tax Exemption Qualifications – Non-Profit Corporations function just like for-profit corporations, but can receive tax-exempt status if they meet at least one of the federal and state qualifications for a non-profit corporation. This company meets at least two of the federal and at least four of the state requirements for non-profit classification.

Federal – This NPC meets the charitable/benevolent requirement by providing affordable and available mortgage financing for all Texans and assisting with home ownership initiatives. It meets the educational requirement by providing free financial education programs to citizens with an emphasis on achieving prime borrower status and encouraging wealth building through real estate ownership. Every citizen should be taught what it takes to acquire a home and own it free and clear by retirement as part of their quest to achieve economic independence and enjoy the American Dream.

State – This NPC meets the charitable/benevolent and educational requirements, but it also fulfills two others. Since Texas has no state income tax and is primarily dependent on property and sales tax revenues for its operations, it supports a civic mission by supporting real estate values with affordable financing which enhances property tax revenues. It also fulfills the professional requirement by providing responsible lending guidelines and parameters for Texas mortgage lending institutions. Additionally, it provides a secondary market conduit for community banks and credit unions which will help avoid systemic risk issues when interest rates rise.

This NPC can and should pay its executives market rates for salaries and wages to ensure it will attract and retain talented, experienced industry professionals. Politicians need not apply.

Non-Profit Loan Servicing Corporation – In light of the recent news regarding questionable servicing practices among mortgage loan servicers, it would also make sense to have the state create a sister non-profit servicing company to service the loans securitized. This would enhance the ability to track information regarding delinquencies and pre-payment speeds for investors. Using its net operating reserves, it could become a valuable resource for individuals who find themselves in need of temporary mortgage help and counseling. If a homeowner suffers an unforeseen circumstance such as a job loss, a medical emergency, a death in the family, a divorce, or any of life’s happenings that cause temporary financial hardships, having a servicer in a position to make one, two or three payments on behalf of the borrower (while adding them to the back-end of the loan) would be a godsend to many and would additionally mitigate the risk of default.

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I believe this business model has the potential to be superior to Fannie Mae, Freddie Mac, or any other government or private market alternative. This business model helps diversify the industry away from Fannie, Freddie, and the federal government; it minimizes taxpayer risk, it mitigates risk from profiteers and well-meaning politicians, it protects and strengthens the bond between borrower and investor, it’s 100% transparent, and it grows stronger over time. This is not an attempt to reinvent the wheel; it is an attempt to recreate what used to work well with safeguards in place to prevent what went wrong from happening again. If it proves successful it can be duplicated by other states or other regions nationwide (e.g. in each of the 12 Federal Reserve Districts).

The Texas Legislature is only in session every other year for four and a half months at a time. They are currently in session now, and there are only a few weeks left to have this proposal considered during this session. I plan to present this proposal to select Texas lawmakers soon if I am able to gain access to them.

Comments or questions may be posted at http://goodcapitalism.wordpress.com , emailed to rick@rickbaron.com , or discussed directly with Rick Baron at 512-422-1949. Thank you in advance for your input. -rb

“We think the concept has merit and deserves serious further consideration”.

I’ve run the legal and conceptual traps past the entities and agencies that will likely influence and regulate the company, and no one has told me yet why this can’t happen or given me any reason why this won’t work. I have nothing but green lights so far. It makes too much sense, it addresses several issues simultaneously and benefits just about everyone.

This week, I managed to secure a meeting with Dr. Mark Dotzour and Gerald Klassen at the Texas A&M Real Estate Center in College Station on March 15th. They’ve been working on a proposal to reform the national mortgage system, and they’ve agreed to hear me out. I’m hoping they will see the merits of the non-profit structure and possibly incorporate the concept into their proposal. I’m most concerned about Texas, though, so my main priority is to get their blessing on the Texas-backed non-profit corporation business model. If I can get their support, I feel TAR will get behind it which will give the project some serious muscle.

For those of you who are interested, I’d like to share with you my overall strategy and timeline:

1) Run the numbers – Determine if Texas has the economies of scale needed to support its own securitization entity. Yep, it does. See previous posts. With enough scale, it’s an extremely lucrative business.

2) Develop a business model that re-creates the good and safeguards against the bad – The Non-Profit Corporation removes shareholder pressure to increase profits by taking undue risks or raising fees. Proper legislation incorporated into its creation will prevent political meddling. It also takes advantage of existing infra-structure and systems, is 100% transparent and easy to regulate. With tax exempt status and no payouts to shareholders, all net operating profits can be banked in an ever growing guaranty reserve fund. Assuming $10 million in gross profits per $1 billion in securitizations, revenues can easily exceed $200 million per year. An ever growing reserve fund eliminates taxpayer risk and ensures sustainable affordable financing and systemic liquidity. It can become the Fort Knox of mortgage banking.

3) Set standards for credit quality and operations – All loans must be assessed and documented to determine a borrower’s ability and willingness to repay the obligation as well as determine the quality of the collateral. Human underwriters will have final decision making authority over software findings and will be held accountable for their decisions. The company’s purpose is to purchase home loans from lenders, pool them into securities, and sell them to global investors. It should never become an outright investor of its own securities. It should be a leader in public financial education. Excess reserves should be used to support housing initiatives.

4) Run the traps and get a feel for support – It helps to have lived in Austin for over 20 years. I have several friends and clients who work for or with the state. I also know lots of people who know lots of people. Gaining access to the people who will be involved if this project takes off has been much easier than I anticipated. It’s actually been quite fun up to this point. So far no red lights, all green lights.

5) Solicit support from industry groups and associations – The Texas Association of Realtors, the Texas Association of Home Builders, the Texas Mortgage Bankers Association, The Texas Association of Mortgage Brokers (& Professionals), the Independent Bankers Association of Texas, the Texas Credit Union League, the Texas Bankers Association, etc. should all be interested in supporting the concept. I started with TAR, and will be contacting the remainder in the next few weeks.

6) Develop a social networking strategy to rapidly gain broad awareness – This blog, email, FaceBook, Linked-In, and YouTube all need to be utilized to the fullest extent possible to explain the concept and ramp up support. Right now I’m working on both a video explanation and a PowerPoint presentation of the concept. My skills are rudimentary in both, but I hope to have something decent posted by mid March or so. The concept needs to go viral among Texas real estate industry professionals and state politicians. I’m encouraging all who have contacts with officeholders to open dialogue about the concept.

7) Develop data to support the probability of the positive impact this project will have on state and school district budgets – I’m currently gathering data to illustrate the lost equity in the $500k to $1 million price range due to the lack of available and affordable financing in this range over the last three years. A Texas conforming loan amount of $750k with common sense guidelines will go a long way toward restoring this lost equity and will increase property tax revenues without raising property tax rates. A more normalized lending environment will also allow many more people to refinance to lower rates and payments, freeing up more disposable income for Texans to spend with the result being increased sales tax revenues. If this case is well established, this project stands a good chance to become a budget item and dramatically increases its odds of being created.

8) Identify and target possible sponsors to file the charter – I have four gentlemen in mind right now, but I’m still researching. I plan on attempting to make contact with some of them after the A&M meeting to begin preliminary discussions.

9) Determine the timeline – I’m meeting with the A&M guys on March 15th. After that I plan to post a video followed by a PowerPoint presentation. I hope to have gained the support of TMBA, TAMP, TAHB, TBA, IBAT, TCUL and hopefully TAR by the first week of April. The Texas Association of Realtors has its Capitol Grounds Day on April 12th, and nothing would please me more than for this project to be the main topic of conversation.

10) Close the deal – If I’m able to get in front of the right people, I’m confident I can persuade them to act and file the charter. It won’t cost the state any money to create, it’s self-funding and self-strengthening, it helps avoid systemic risk in our state and local banking systems, it keeps financing affordable relative to private market rates, it positively impacts property and sales tax revenues, it can be up and running inside of a year, and it can be a model for other states or regions to duplicate. It also builds a protective fence around the Texas real estate market and pokes a finger in the eye of Washington and Wall Street. What’s not to love? We can do this, we should do this, and we must do this.

My goal is to have it officially in play by the end of April and formally established by June. I’d like to see fund-raising started by sometime in July but no later than August. Please help spread the word and show your support by becoming a subscriber to my blog at http://goodcapitalism.wordpress.com . rb

I have read every page of the Treasury/HUD Housing Finance Reform Report to Congress, as well as the Mortgage Bankers Association’s reform proposal and the Texas A&M Real Estate Center’s reform proposal. They all suggest the function of mortgage securitization should be handed over to a heavily regulated private market. The only private entities I’m aware of with the financial wherewithal to perform such a task are Wall Street firms. I suppose they think Wall Street did such a fine job doing this over the last ten years we’re just going to let them do it permanently.

Aside from the fact that there currently is no private MBS market, I can’t begin to list all of the problems this will create for our industry. The most obvious and largest factor is that borrowing costs will be substantially higher than they are now, and we’ll all suffer as a result. There is also the difficulty in maintaining uniform credit standards and the difficulty in requiring transparency from private sector corporations. Profit pressure from shareholders will increase the risks, which is a large part of what got us here.

I believe I have found a better way.

My name is Don Quixote (a.k.a. Rick Baron), and I am attempting to lead the Texas and national mortgage industry into a slightly different direction. Instead of trying to shift mortgage finance risk from government to the private markets or vice-versa, I am proposing a business model that has a much higher potential to balance the risks equally among everyone. It will be good for the homeowner/borrower, the lender, the government, the housing industry, and most importantly, the investor. It is called the Non-Profit Corporation.

The non-profit structure is, in my professional opinion, the only business model that can mitigate all of the risks properly. It removes shareholder pressure to take undue risks for the sake of higher profits. If structured properly, it removes the risk of government pressure to lower credit standards. Taking risks for profit’s sake (i.e. investing in and owning outright sub-prime mortgages) and lowering credit standards is what brought down Frannie.

Because it will not be distributing its operating profits to shareholders, the Non-Profit Corporation can, over time, build a formidable guaranty reserve fund to reassure the investors in its securities they will get their investments back.

Because it will not be a government agency and assuming proper legislation is put in place, politicians will not be able to meddle with its funds or credit standards in any way, nor will taxpayer funds be put at risk.

Because it will be a Non-Profit Corporation, it will be 100% transparent and easy to regulate.

And because it will not be allowed to own any loans/securities any longer than it takes to securitize and sell them to investors, their operations would guarantee the minimum exposure to the risk of losses.

Its primary function will be to act simply as a conduit, connecting Texas lenders to global investors. This will ensure the continued availability and affordability of mortgage financing. By purchasing long-term loans from short-term lenders, securitizing them, and selling them to long-term investors, it will ensure the liquidity of our state-wide financial system.

Its benevolent mission will be to educate all Texans on best practices of money management. This will help to support a growing pool of qualified home buyers.

For it to be a real benefit and a successful venture, though, it will need to be a large enough operation to achieve economies of scale. We will need to raise a substantial amount of money to get it up and running.

But most importantly, for global investors to perceive that Texas Mortgage-Backed Securities are a safe, solid investment with a decent return, it will need the Great State of Texas to stand behind it.

I believe I have figured out a way for us to do this without ever using and without ever risking Texas taxpayer funds.

For the past six months I’ve been running the traps – crunching the numbers, checking for legal barriers, speaking with MBS investors to get a feel for their interest, etc. So far, everything has checked out beautifully.

In the past few weeks I’ve managed to meet with some legal counsel folks at the Texas Association of Realtors and the Executive Director and others at the Texas Department of Housing and Community Affairs. I’ve spoken to and have a meeting scheduled with the Commissioner of the Texas Department of Savings and Mortgage Lending. I’ve also been engaged in conversations with the Texas A&M Real Estate Center. To this point, everyone is interested, intrigued, and thinks the idea has merit and deserves further consideration. The A&M guys have given me the most resistance, but they are focused on their proposal to remake the national system. I’m hoping to meet with them in early March to further explore the concept and hopefully get their blessing.

My immediate goal is to persuade the Texas Legislature to sponsor and charter a 501c3 in this session. They’ve done it before, in 1993, when they established the Texas State Affordable Housing Corp. (TSAHC) to serve the low income sector with affordable financing. We can use TSAHC as a template. We don’t need to ask for any funding, we just need to get the legal framework in place.

But before I go there, I will need the support of industry professionals. Realtors, builders, title professionals, appraisers, sub-contractors, mortgage bankers and brokers, financial institutions, and all others connected to our industries need to be aware and supportive of the concept. We need to create some buzz about this as soon as possible.

We desperately need to build a competitive alternative to Frannie. Currently, over 95% of the mortgages made in the U.S. go through the Federal Government. The best medicine for a monopoly like that is a stiff dose of competition. Our economy and our markets are large and healthy enough to support such a venture.

Frannie’s credit standards are now so ridiculously strict only a fraction of loans submitted are being approved and purchased by them. The good loans that they reject are being made by community banks and credit unions and kept on their books. There is no ready-made secondary market for them, so if and when interest rates spike we may see another systemic risk crisis. This Non-Profit Corporation will help prevent this scenario.

With a state backstop, an ever growing guaranty reserve fund, responsible and uniform credit standards, and 100% transparency, global investors will perceive the securities as lower risk and will accept lower yields relative to purely private label MBS. This aspect translates into lower interest rates for borrowers. If things unfold on the national level as intended, doing this could potentially put us in the position to offer the lowest mortgage interest rates in the entire United States.

I’m asking for your support to make it a reality. Spread the idea to everyone in the industry (Realtors, builders, title, subs, etc.), and contact your state representatives and warm them up to the idea. If they have any questions, feel free to have them contact me directly. All we need to do is persuade them to establish the 501c3. We don’t need any funding to do this part. We can raise the start-up capital from real estate-related industry professionals after the legal framework is in place.

Assuming my meetings with TDSML and the A&M guys go well, in the first half of March I will share with you my strategy to persuade the Texas Legislature to file the charter. This is going to be interesting, folks. This will work, but we only have a narrow window of opportunity. It will work better than any other option currently proposed, and it is a permanent solution to the mortgage finance system and can be duplicated nationwide. We can build a better system, but we have to act soon. If everything goes as I think it can, we can have this company built and operational inside of 12 months. Please help spread the word.

For updates, please visit my blog at goodcapitalism.wordpress.com . I can be reached at rick@rickbaron.com and by phone at 512-422-1949. Stay tuned… rb

It’s as if we spent 25 years building a state-of-the-art computer to connect lenders to investors and enhance market liquidity. But like most folks in the ‘90’s, we forgot to install a firewall or any anti-virus software. When we plugged into the internet, Congress hacked into the system and infected it with sub-prime viruses and Alt-A malware disguised as Affordable Housing Programs. There was no firewall (or law) to prevent them from doing it. They corrupted the system.

Then the shareholders & CEO’s of Fannie and Freddie looted the corporate treasury. Then they handed over risk assessment (loan decisions) to software that assumed Real Estate values would always go up, and they don’t. The software also could not tell if you were lying to it. Human beings were no longer held accountable for responsibly assessing risk.

Then we handed securitization over to Wall Street, and handed originations over to unemployed and unlicensed computer nerds and twenty-year-olds. Soon anyone with a computer and an internet connection could get in the mortgage business and get rich, and here we are. Duh.

The system has not failed; it’s just been corrupted, infected and damaged. The system crashed in 2008, but we managed to reboot in Safe Mode. It’s still functioning, but just barely, and now we want to unplug it and scrap it.

We need to convert Fannie Mae into a Non-Profit Corporation. This would remove pressure from shareholders to take undue risks for the sake of profits. We need to build a legal firewall to keep Congress out of it completely. They should never be able to dictate credit quality or meddle with its money or its purpose. The Non-Profit Corporation would exist BETWEEN the government and the private market, not UNDER either one or both. The Non-Profit Corporation is the only business structure that can insulate the system from both government and private corruption. The Non-Profit Corporation is totally transparent and easy to regulate responsibly.

We need to put HUMAN BEINGS back into the risk assessment business and hold them ACCOUNTABLE, but also allow them to override software findings (when it makes sense and they document and justify their reasons).

All net profits (currently averaging over $10bln/yr) should then be BANKED as an AGENCY GUARANTY RESERVE FUND (not a government guaranty) and built up over time to make it the Fort Knox of mortgage banking.

We need to turn Freddie Mac into a second RESOLUTION TRUST CORPORATION (FRTC). Shift all of Fannie’s sub-prime securities (B Paper) over to Freddie, and all of Freddie’s prime loans (A Paper) to Fannie.
Then systematically modify ALL of the sub-prime loans that it owns outright to new 30 year fixed rate loans at 1% above current Fannie Mae 30 year fixed rates, no questions asked. None of these people qualified in the first place, so trying to make any of them qualify for a lower payment is just foolish. That’s why the modification programs tried so far have failed.

Give FRTC the rest of TARP money and a line of credit with the Fed to buy any and all B paper from any and all interested parties for .50 cents on the dollar of original value. Paying .50 cents on the dollar would help banks restore capital reserves and get the viruses off of their books and quarantined inside the FRTC. They could then go back to normal lending.

Once the U.S. owns them as the investor, systematically modify all of them as well. Then intensively counsel all of them on how to manage their money and live within a budget that works.

On the Pay Option ARM’s, systematically modify all of them to fully amortizing 3/1 ARM’s with 2/6 caps at Wall Street Prime plus a half-percent.

Once the loans show a history of performing, repackage them into MBS and sell to investors at a profit and recoup most of the money spent. That’s why the rates need to be set at 1% above the current FNMA rate – to offer an attractive yield to investors. If the loans are modified to below market rates, they will likely remain illiquid, especially when market interest rates rise.

Systematically modifying the loans to lower rates and payments will immediately create an enormous economic stimulus and give the borrowers a fighting chance to keep their homes.

Turning Fannie into a Non-Profit Corporation would prevent what went wrong from ever happening again, and the reserve fund would return us to an ever growing AGENCY guaranty instead of a Government guaranty. However, the GOVERNMENT BACKSTOP IS THE FULFILLMENT OF AFFORDABLE HOUSING GOALS because it keeps mortgage interest rates well below private market rates and competitive with long term Treasury yields.

This solution is a good idea. It will work. It will repair and continually strengthen the financial system and allow lending and credit standards to return to a more normal level. It will stimulate the economy and job growth as a result. It’s easier to implement and could be accomplished more quickly than the other proposals. It restores our mortgage and financial system to a state that we know works well, and will protect it from being compromised or infected ever again.

My faith in Congress doing the above, which is workable and makes sense, is zero. I’ve been lobbying Texas agency heads and politicians to create a non-profit corporation for Texas to function as a Frannie in case of emergency. We could put additional ones in each of the Federal Reserve Districts to take the pressure off of Fannie, diversify risk and be in a better position to respond to regional market changes quickly.

Common sense has left the mortgage industry, and we’re so risk-averse now we’re choking the industry out of business. If rates spike, we’re dead in the water. The small banks and credit unions taking all the “approve/ineligible” loans will get caught in the S&L trap of the late ’70′s/early ’80′s (higher cost short term money with lower yield long term loans) and they have no ready-made secondary market . Can you say “Systemic Risk II“?

Right now we’re observing a massive train wreck in slow motion, and we’re in the car floating end-over-end through the air assuming Congress will fix everything before we hit the ground. Pull your heads out, people. We need smart, swift & bold action and we need it now. The above could be implemented quickly and cheaply, would stimulate jobs and the economy, and would put the mortgage finance and banking system on a sustainable path. We should have done this in 2008 with the original TARP. We can still do it. All other options I’ve seen will take too long and will likely make everything worse.

Can anyone tell me why this will not work? Will someone please help get behind this idea? I’ll be happy to put this all together for us for a two year consulting contract and a seat on the Board of Directors (so I can make sure no one screws it up). Just let me know. rb

• For over six decades, Fannie Mae (and later Freddie Mac) served a vital role in providing affordable financing for homes in the U.S. They had the most sophisticated, conservative underwriting philosophy and risk assessment best practices ever devised, requiring good credit, down payments and income verification to ensure borrowers had both the ability and willingness to repay their mortgage debts.

• In the mid 1990’s, HUD and Congress began requiring Fannie and Freddie to purchase sub-prime mortgages and mortgage-backed securities. This was equivalent to the FDA requiring Proctor & Gamble and/or Johnson & Johnson to purchase lead-tainted baby formula from China because it was more affordable. By 2007, they owned or guaranteed over $1.5 trillion of sub-prime loans and securities.

• Congress now wants to eliminate, shrink, or split up and privatize Fannie and Freddie. Because of the toxic nature of sub-prime loans (predatory terms given to unqualified borrowers), Fannie Mae and Freddie Mac are now technically insolvent. Over 90% of all mortgages now go through the Federal government. As long as our wagon stays hitched to Fannie and Freddie, we go where they go.

• If all mortgages are forced to go through private markets, interest rates will at least double. Bill Gross of PIMCO says that if mortgages all go through private lenders, interest rates will increase by 4.00% or more. Paul Volker recently stated the national mortgage market is broken. Both parties in Congress are working on bills to shrink, split up, privatize, or shut down Fannie and Freddie.

• The State of Texas has avoided the majority of the mortgage market meltdown. We had no real estate bubbles this time around, our economy emerged from our real estate crisis in the ‘80’s much stronger and more diversified, and our state regulatory structure minimized much of the irresponsible lending practices of the last decade.

• Texas is averaging $40 billion per year in residential real estate sales. We have the 15th largest economy in the world if measured as a country, the number one export economy of any state, and our population, economy, and job markets are still growing.

• Texas would be extremely wise and well served if we created our own secondary mortgage market institution. This company would be a viable alternative to Fannie and Freddie, and would ensure the availability and affordability of mortgage financing if Fannie and Freddie shrink or go away. This company would exclusively serve the Texas real estate market and provide basic, old-fashioned, conservative loan products that minimize risk to investors and never put taxpayers at risk if structured properly.

• We are strongly requesting the Texas Legislature pass legislation (through statute and/or charter) that will allow this entity to exist. Doing so would at least give us a “Plan B” in the event Fannie and Freddie collapse. With a state guarantee for investors, it would keep mortgage interest rates affordable for Texans and secure the foundation of our real estate market.

• Initial funding could come from state and local banks and credit unions, as well as all housing industry related professionals. For example, the top 100 strongest institutions could contribute $1 million each, totaling $100 million. Otherwise, they could contribute a lesser amount and the difference could be made up by Realtors, mortgage professionals, home builders, appraisers, sub-contractors, title companies, etc. The company could then borrow up to $1 billion from the Fed window for initial purchases. All proceeds from activities (in excess of operating costs) could be reinvested to strengthen capital reserves for the first several years. No taxpayer dollars would be used or at risk.

• The Texas Conforming maximum loan amount should be $750,000. This would breathe new life into our upper-end markets which have been decimated due to the lack of available financing in this range. The current state-wide maximum Fannie/Freddie conforming loan amount is $417,000. Even borrowers below the $417k level are currently finding it difficult to get approved due to the overly restrictive requirements of Fannie and Freddie.

• A Texas-only secondary mortgage market corporation created by Texas for Texans and supported by Texas investors would protect the foundation of Texas real estate. Potential investors such as the State Retirement System, the Teachers Retirement System, oil companies, life insurance companies, and just about every other entity in the state looking for a safe place to invest would certainly see this institution’s securities as a viable alternative to the currently uncertain world of investments.

Proposed Structure and Safeguards for this Institution

1) The most practical structure for this entity should be as a 501c3 non-profit corporation. Such a structure would be totally transparent, 100% regulate-able, and chartered by the state using the Texas State Affordable Housing Corp. (TSAHC) as a template. Initial funding should come from  state banks, local banks, credit unions, thrifts and savings institutions as well as all related industry groups and professionals. If 200,000 real estate related professionals each made a $500 tax deductible contribution, we would have $100,000,000 in start-up capital.

2) With $100 million in capital, the institution could borrow up to $1 billion directly from the Federal Reserve. This would enable it to purchase up to $1 billion in mortgage loans from state and local institutions. Doing so would replenish the state and local institutions’ funds and enable them to make more new loans.

3) The company would then pool and securitize these loans and offer them as investments to Texas based investors such as: Public state and local pension funds, insurance companies, corporations, and wealthy individuals. Pool sizes could range from $5 million to $500 million in size. The securities should only be structured as “pass through” securities, which is the simplest structure for this type of security. Once the securities are sold to investors, the proceeds will reimburse the funds borrowed from the Fed and the cycle would start over.

4) Company profits would be derived from a .50% up-front fee, as well as a monthly guaranty fee of .375%. For example, using simple math, for every $1 billion in loans purchased, the company would receive $5 million initial fees, and approximately $3,750,000 per year in annual revenues from the guaranty fees. The guaranty fees insure investors against any losses, making these securities a safe, reliable investment.

5) All profits over and above operating expenses should be banked and added to the initial $100 million for the first several years until the company can guarantee all of its securities on its own. At that point, the decision could be made to either continue the company in its current form or go public and sever its relationship with the state.

6) Only in the event of a sudden collapse in the national mortgage system would the state need to inject funds to quickly enhance the company’s purchasing capacity. If mortgage financing seizes up, the state could inject up to $1 billion and enable the company to borrow $10 billion from the Fed to keep the flow of mortgage money going. This would only be in an extreme circumstance, but at least we would have a vehicle in place to utilize if needed.

7) Loan products offered would be limited to traditional and conservative products only (i.e. fixed terms, required down payments, no pre-payment penalties, fully documented income and assets, good credit, etc.). It would also ensure state-wide uniformity of loan products. Underwriting would be based on common sense risk assessment, and human beings would be required to make the final loan decision, not underwriting software.

8)  The company should not be allowed to lobby the legislature for as long as the state is affiliated with the company.

9) The state legislature should never be allowed to require the company to offer or purchase any mortgage products that do not meet the highest standards of credit quality and prudent risk management practices set forth by the company. It should also never be able to siphon funds from this entity.

10) Part of the company’s mission should be to educate Texans on the best practices of financial management, credit and debt management, and conservative wealth-building strategies with a special emphasis on Texas Real Estate.

The goal is to create a mortgage financing system for the State of Texas that is entirely separate and independent from the national system and the national banks. At a minimum, this would give us a competitive alternative to the current system. Fannie Mae and Freddie Mac, as well as all of the largest nationwide banks, are saturated with sub-prime and toxic securities and are now in foreclosure quicksand. In a worst case scenario, this institution may be the only way to ensure the continued availability and affordability of mortgage financing in Texas.
Creating this institution will take an enormous collective and collaborative effort from our mortgage, real estate and title insurance industries. However, the first step will need to be taken by our Texas Legislature to lay the legal groundwork to allow this institution to exist. We could then target the end of 2011 to have the entity up and running.

We are seeking the endorsement of lenders, Realtors, and title companies and their organizations to help persuade the State Legislature to act on this measure. Please support the concept and encourage other Texans to do the same.

Rick Baron
NMLS #220934

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

But for those of us who are still left standing in the mortgage business, we have a lot to be grateful for and even more to look forward to. We’re still making loans! And in Texas, we’re doing better than just about every other state in the U.S. Ever wonder why?

Back in 1980, inflation was running in the double digits. Savings banks and Savings and Loans were regulated by Uncle Sam and only allowed to take in savings account deposits and loan out long term mortgages. They were struggling in that environment because deposits were bleeding out to chase higher yields.

As a quick fix, Congress lifted the interest rate caps on what they could pay and they also increased the FDIC insurance on deposits from $40,000 to $100,000, so money came flowing back in.

But because S&L’s loan portfolios were made up of long term, low fixed rate mortgages, they quickly found themselves losing money again. As another quick fix, Congress lowered their reserve requirements to 3% from 5%, allowed them to lend up to 70% of their portfolios for consumer loans and commercial real estate, and lifted the restriction of local ownership of S&L’s. These changes effectively let them become full service banks without having the reserve requirements of full service banks and ignited a lending frenzy.

At the time, the Texas economy was primarily based on the oil and gas and real estate industries. The easy money from the S&L’s fueled a speculative bubble in both residential and commercial real estate. By 1985, the S&L’s began to collapse from irresponsible lending and the real estate bubble burst. Congress sends in the Resolution Trust Corporation to clean up the mess and the rest, as they say, is history.

So why is it different for us this time around? Because, my friends, we didn’t drink the Kool-Aide. We learned our lesson in the 80’s. Our state and local banks didn’t buy into the sub-prime mbs game and kept their reserve ratios high. We spent the 90’s and continue today attracting a wide variety of industries like technology, aerospace, defense, manufacturing, medical, biotech, and alternative energy. Our population is still growing and our job market is holding up well compared to other states. We now have the 12th largest economy in the world and the number one export economy of any other state. Our home equity laws, not passed until the late 90’s, are conservative and kept us from over-borrowing. And most importantly, we didn’t have any speculative real estate bubbles like was seen in California, Nevada, Arizona, and Florida. We’re on solid ground, folks, and we’ll be hurt the least and come out of this much sooner than most other states.

Couple that with the facts that nearly two-thirds of our competition has left the business and interest rates are still low, and it sure looks to me like the next year or two can be really, really good for us. All we have to do is show up and work hard.