Uncle Sam's Muddled Mortgage Message – a Quandary for Bankers

Editor's note: A version of this post originally appeared on LinkedIn.

The federal government had a clear message for mortgage bankers at an industry conference in Phoenix this month. It intends to hold them accountable for maintaining the highest standards in underwriting each and every home loan. Except, that is, for the millions of borrowers for whom Uncle Sam wants them to toss standards out the window and offer subprime mortgages.

When it comes to financing the average middle-class American, our government-backed mortgage entities will accept nothing but the most pristine standards. Just what qualifies as pristine is a complicated business. Government-sponsored mortgage insurer Fannie Mae lists 200 potential "defects" in mortgage documents. They run the gamut, from mistakes in tallying self-employed income to improperly evaluating the accessibility of a private road ingress/egress. Regardless of pressures lenders face to keep costs down, the government regards even a single error as unacceptable.

What’s more, Fannie and its sibling, Freddie Mac, are for the first time creating formal programs to flag defective loans and assess risks in lenders’ mortgage processes. If loans have flaws, Fannie and Freddie will require lenders to repurchase them immediately.

"We don’t buy defective loans," declared Steve Spies, vice president for loan quality at Fannie Mae, during a presentation to mortgage risk managers at the Phoenix gathering. Spies recommended that industry officials bookmark Fannie’s portal page listing the 200 loan defect categories.

Finding quality time to spend with Fannie’s defects might prove challenging to mortgage officials, given everything else that’s on their desks these days. That includes the qualified mortgage rule, drafted to make lenders responsible for ensuring that borrowers have the ability to repay their mortgage loans. QM weighed in last January at 804 pages and is in the midst of significant revisions. It’s also scheduled to be part of what industry insiders are referring to as the "January effect" early next year when a mountain of new mortgage regs will go to into effect.

Separately, the qualified residential mortgage rule, designed to force mortgage originators to retain a portion of their loan risk, is also set to go into effect in January. It remains in draft mode.

Complying with a mass of new regulation to make sure every loan is sound and defect-free is only part of what the government expects of mortgage lenders. It also wants them to chuck these standards of care out the window to lend to what it deems as disadvantaged borrowers.

Specifically, the government is enforcing with great vigor a range of so-called fair-lending provisions. The gist is that lenders are to ignore all the talk about fat down payments, ensuring borrowers' ability to repay and the like when it comes to fair-lending applicants.

The Federal Housing Administration recently went so far as to cut to one year from three how long borrowers must wait after losing a home to foreclosure or a short sale before qualifying for a new mortgage. (To be eligible borrowers must show their foreclosure or bankruptcy was caused by a job loss or income reduction beyond their control. Do that and the feds deem it appropriate to pass on to others the risk of your do-over.) The FHA's change has prompted real estate companies in hot markets like Las Vegas and Phoenix to specifically target "boomerang buyers," the Wall Street Journal noted recently.

One Phoenix conference speaker expressed shock that Shaun Donovan, the secretary of Housing and Urban Development, which runs the FHA, has referred to these low-down-payment mortgages to recently failed borrowers as "plain vanilla" loans that can be made safely.

Most of those loans are passing through the FHA and Veterans Administration before getting packaged into mortgage bonds by Ginnie Mae, the government-backed guarantor behind FHA and VA loans.

"There’s a lot of credit risk" from these mortgages, Anand Bhattacharya, a finance professor at Arizona State University and mortgage expert (who spoke on a panel I moderated) told me. "It’s sort of the new subprime. If you looked at the average credit profile of these [FHA and VA] borrowers, it's worse than subprime."

The mortgage risk specialists at the conference also sat through a session about how the federal government has been going after home lenders over discrimination claims with unprecedented vigor since 2010, when the Department of Justice appointed a Fair Lending Task Force.

Bolstered by the theory of "disparate impact," the DOJ and other federal agencies are prosecuting lenders over statistical analyses indicating that, even if they had no intention of discriminating, their business practices have resulted in more loans going to some groups than to others.

Lenders were cautioned that it's futile to resort to the insanity defense – in this case meaning to argue that the law's insane (a prospect that the Supreme Court will take up later this year). Instead, they were advised to hire or appoint fair-lending officers and do their own statistical analyses before the feds come knocking. If the results are unfavorable, the antidote, presumably, is to balance things out by lending to members of specific ethnic groups — even if that means running afoul of all those rules and regulations about qualified mortgage standards, zero defects and the like.

Neil Weinberg is the editor in chief of American Banker. The views expressed are his own.