Late last year, the Federal Housing Finance Agency announced a new framework for representations and warranties the underlying facts that ensure a loan will perform well on loans sold to the government-sponsored enterprises, Fannie Mae and Freddie Mac. The framework is an attempt to define, at a strategic level, some key boundaries guiding the GSEs in their purchase of quality loans.
While this framework is a welcome step in the dialogue over the GSEs' policies, it has not had the intended effect of giving lenders the certainty they need to expand credit through new originations and loans sold to the GSEs an important element in our nation's economic recovery.
Uncertainty surrounding representations and warranties is hindering a full recovery of the mortgage market, hurting the availability of home loans for qualified borrowers.
There are three key flaws in the framework that should be addressed in order to provide certainty for lenders as they consider making new home loans and overall stability for the market.
First, the framework allows the GSEs to require a lender to repurchase a loan that has defaulted for unpredictable reasons, such as the death of a borrower or a divorce. Lenders who have performed in good faith in underwriting a loan should not be penalized for later, unpredictable events they cannot control. The FHFA should address this.
Second, the framework allows the GSEs to require lenders to buy back loans as late as three years after that loan is sold to the GSEs. We believe the period for this "sunset provision," meant to protect the GSEs from buying bad loans, is too long. If a loan fails because of poor underwriting, it generally happens in the first year to 18 months. Before the financial crisis, the industry standard was between 18 and 24 months, and a sunset of 24 months is where the new standard should be. This will still protect GSEs but will help provide certainty for lenders.
Finally, the framework allows the GSEs to shorten the amount of time a lender has to respond to a repurchase request. This forces lenders to repurchase a loan in order to avoid the uncertainty of prolonged litigation. The frequency of these cases is making lenders increasingly uneasy about selling loans to the GSEs, which only hurts the fragile housing recovery and ultimately consumers as well.
These uncertainties can be resolved with a simple principle in mind: after a loan is sold to the GSEs, the lender bears the risk if the loan is flawed due to faulty underwriting. If a lender sells a loan to the GSEs and the borrower defaults, the lender should be forced to repurchase the loan if the lender did not adequately evaluate whether the borrower could repay.
However, if the lender did its due diligence, and the default occurred because of an unforeseeable circumstance, then the government should not be able to force the lender to buy back the loan.
If the FHFA makes these revisions to the framework (which the Housing Policy Council outlined in further detail in a recent white paper) it would give lenders and investors renewed confidence in the mortgage market.
John H. Dalton is the president of the Housing Policy Council at the Financial Services Roundtable.