TH on LLPA: "FHFA is just carrying through on what it announced it would do earlier: it’s increasing upfront fees (Loan Level Price Adjustments, or LLPAs) on products or loan features it thinks Fannie and Freddie should be doing less of–such as second homes, investor properties, cash-out refis and even rate-and-term refis–while also lowering LLPAs for features it associates with affordable housing loans. In making these changes, FHFA claims it’s “developing a pricing framework to maintain support for single-family purchase borrowers limited by weal?th or income…fostering capital accumulation, and achieving commercially viable returns on capital.”
FHFA’s not doing any of those things. The biggest change FHFA could (and should) make to help Fannie and Freddie support affordable housing is to get rid of all of the conservatism, minimums, cushions and buffers in their “risk-based” capital standard, which cause them to have to put unnecessarily high guaranty fees on ALL their loans (as I discussed in my August 2022 post, “Mind the Gap”). But Director Thompson won’t do that. Instead, she hopes to achieve a very rough form of cross-subsidization by raising LLPAs on some (mainly lower-risk) loans while lowering them on affordable housing loans.
Aside from the fact that this doesn’t solve the overall pricing problem caused by gross overcapitalization, it’s also likely to LOWER Fannie and Freddie’s returns, because the LLPA cuts on affordable housing loans still leave the total guaranty fees (base guaranty fee plus amortized LLPA) on these loans much higher than warranted by their risk–thus not attracting that much more volume–while the huge jumps in LLPAs for low-risk refi business will drive much of that business to the banks, and may even prompt a restart of the hugely inefficient private-label securitization process. So with Fannie and Freddie doing less lower-risk business at higher fees, and more higher-risk business at lower fees, their overall mix of credit guarantees will shift more to loans that are underpriced relative to the Calabria standard, at the same time as that same standard will require a greater percentage of capital because a significant volume of lower-risk loans will have gone elsewhere. The result will be a lower, not a higher, return on the companies’ “Calabria capital.”
This, unfortunately, is what you get when you have politicized bureaucrats running complex, sophisticated, market-based institutions like Fannie and Freddie: simple solutions that look good–and can be turned into a great press release–but won’t work. And we will likely have to wait until it is “glaringly apparent” that these LLPA changes are NOT doing what Thompson thought they would before FHFA feels compelled to try something different–unless, that is, the Biden administration wakes up to what’s going on and replaces Thompson with someone who understands Fannie and Freddie’s business, and values the role they could play if removed from the straitjackets former Director Calabria put them in."
AI
