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Crisis calls for review of mortgage agencies’ mission

(Published by South China Morning Post, 26 Mar 2008)

Recently, as the global credit crisis continued to unfold, the two largest quasi-government mortgage companies in the United States, Fannie Mae and Freddie Mac, were again subjected to intense scrutiny. While several issues have been raised, one critical concern was whether their deteriorating financial health was a result of their expansion into mortgage products outside of their primary mission.

Considered as government-sponsored enterprises or GSEs, Fannie Mae and Freddie Mac were created to operate in America’s secondary mortgage market to ensure that loan originators have sufficient funds to lend to homebuyers at low interest rates.

Their key mission is to help those institutions who house America. Specifically, both institutions buy and/or guarantee residential mortgages in the US which typically meet underwriting standards:

•Maximum loan amount: US$417,000
•Maximum loan-to-value: 80 per cent
•First lien mortgages
•Prime mortgage borrowers (or borrowers with high credit scores)

At the end of last year, Fannie Mae owned or guaranteed about US$2.53 trillion of single-family mortgages, about 25 per cent of US home loans outstanding. The market estimates that about 5 per cent of Fannie’s portfolio is considered subprime – borrowers with credit scores below 620, while Fannie puts its overall exposure to subprime mortgages at US$54.1 billion and its exposure to Alt-A loans – a category between prime and subprime, typically involving loans for which borrowers do not fully document their incomes – at US$350.6 billion.

In total, according to Wall Street estimates, almost 16 per cent of Fannie’s portfolio is in jeopardy of suffering high defaults, which does not include prime residential mortgage assets which are starting to show signs of contagion as home equity values continue to spiral exponentially downward across the country.

From recent financial disclosures by Fannie Mae and Freddie Mac, it seems evident that as a result of deviating from their core mandate and into higher risk mortgage product areas – buying or guaranteeing second mortgages, Alt-A and subprime residential mortgages – the combined losses of both companies exceeded US$9 billion in the second half of last year.

For this year, market estimates losses for both institutions will exceed US$15 billion.

Fortunately, the one area of the US mortgage financing market where Fannie Mae and Freddie Mac are not allowed to operate is mortgage insurance.

Mortgage insurance provides protection to mortgage lenders from borrowers who opt to borrow more than the conforming loan-to-value (LTV) limit, which is 80 per cent in the US.

The five largest US mortgage insurers – MGIC, Genworth, Radian, United Guaranty and PMI – have reported or are expected to report billions of dollars in losses for last year. Because of the high-risk nature of this mortgage market segment, risks were adequately diversified and borne by specialised private sector companies. As a result, the losses incurred by any of the individual firms have not exacerbated the high-LTV mortgage financing market.

The growing consensus in the US is that Fannie Mae and Freddie Mac should not have engaged in the high-risk segments of residential mortgage lending. These should have been left entirely to the private sector.

In Asia, there are quasi-government mortgage companies in Malaysia, South Korea, Thailand and Hong Kong. The Malaysian, Korean and Thai institutions have generally stayed within their core mission by assisting prospective homebuyers finance home purchases with low-risk mortgage products.

Nevertheless, the Malaysian entity recently announced a plan to establish a company to guarantee high-LTV mortgages.

In Hong Kong, the 100 per cent government-owned mortgage company has ventured into mortgage insurance for high-LTV lending (recently it even introduced mortgage insurance for investment properties) and origination/purchases of second mortgages. Most notably, it has also bought a large portfolio of residential mortgage loans outside of its home jurisdiction – in Korea. This purchase of Korean mortgages now accounts for more than one-third of its entire mortgage portfolio.

While the Asian mortgage markets have thus far weathered the financial tsunami which has battered global markets in recent months, should government-owned or sponsored mortgage companies in the region now review their mission and remain true to their primary mandates?

The conservative school of thought says these agencies should remain prudent and focused on the core mission, while another view maintains that they should be encouraged to expand beyond their original mandates.

Leland L.Sun

Leland L.Sun
Director and Founder of Pan Asian