DS News

50 FAIRHOLME: STATUS QUO MAKES ANOTHER BAILOUT 'INEVITABLE' e Net Worth Sweep, or the sweeping of all Fannie Mae and Freddie Mac profits into Treasury, has been under more intense scrutiny as of late since some of the documents related to Fairholme Funds' lawsuit against the government over the Net Worth Sweep were unsealed in April. e recently unsealed documents suggest that key government officials, namely Fannie Mae's CFO, may have known that the GSEs were on the verge of huge profitability when the bailout agreement was amended in August 2012 to start the Net Worth Sweep. As a preferred stockholder in the GSEs and one of the Enterprises' largest investors, Fairholme has one of 22 current lawsuits against the government that involves the Net Worth Sweep. "We have made enormous progress over the last 12 months, largely behind the scenes," Fairholme CEO Bruce Berkowitz said in a recent interview. "With each passing day, we seem to be getting closer to the finish line, so I remain very optimistic." Add to that the fact that the GSEs' capital buffer is being reduced by $600 million per year until it reaches zero by January 1, 2018, as well as the fact that Freddie Mac has suffered a loss in two of the last three quarters, and many stakeholders in the mortgage industry, as well as GSE investors and shareholders such as Fairholme, are deeply concerned about the possibility of another taxpayer-funded bailout. "Fannie and Freddie have over $5 trillion of liabilities outstanding, yet Treasury is milking them of all their income and forcing them to operate with no capital," Berkowitz said. "It's absurd. If the government takes all of your wealth every quarter as the return on a forced investment, and never allows the repayment of that forced investment, then it is inevitable that there will come a time in the future when the government will force more investment on you, another so-called bailout." To be clear, Berkowitz does not want to get rid of Fannie Mae and Freddie Mac; after all, he said, "Who else makes the 30-year pre- payable fixed-rate mortgage widely available through thick and thin? Who else can provide $7 trillion of liquidity to America's housing market since 2009 helping low and moderate-income Americans buy, rent, or refinance a home?" Berkowitz simply wants the GSEs released from government control, "the same as AIG." He added, "I believe the United States Treasury is growing increasingly isolated as a result of its eight- year policy forcing Fannie and Freddie to remain in a state of captivity known as 'conservatorship.' It is a shame and a huge delay of game." Fannie Mae and Freddie Mac are two of the largest companies in the world, he said, and they are not going away, as evidenced by Freddie Mac hiring hundreds of new employees and Fannie Mae moving into a new million square foot office in Washington, D.C. "It is still hard to believe that some in Washington want to eliminate them in the hope of finding something better, or at least finding something that caters better to their special interests and crony capitalists," Berkowitz said. WHAT IS DRIVING RISK HIGHER ON FIRST-TIME BUYER LOANS? With a greater share of agency first-time buyer home loans comes a greater share of risk involved in those loans. e share of Agency first-time buyer loans surged by 18 percent in April up to 58.8 percent, meaning that 58.8 percent of primary owner- occupied home purchase mortgages with a government guarantee in April were first-time buyers, according to AEI's International Center on Housing Risk. Meanwhile, the Agency First- Time Buyer Mortgage Risk Index (FBMRI) shot up to 15.8 percent in April, a series high and an increase of 0.6 percentage points over-the- year. An Agency FBMRI value of 15.8 percent means that 15.8 percent of these loans would default under economic stress similar to what the country experienced in 2007-08, based on performance of loans originated in 2007. e gap is widening between risk on first- time buyer loans and loans for repeat buyers, according to AEI. e Agency FBMRI was 5.6 percentage points higher than the risk index for repeat buyers in April 2016, which was an increase from 5.4 percent from the previous April. Also according to AEI, 54.2 percent of first- time buyer loans were high risk in April 2016— an increase from 52.6 percent a year earlier. "e gap between first-time buyer and repeat buyer mortgage risk levels now stands at 5.6 percentage points compared to 5.4 and 4.7 percentage points in April 2015 and 2014 respectively," said Edward Pinto, codirector of the AEI's International Center on Housing Risk. "e long running seller's market combined with growing loan leverage and weak income growth for entry-level buyers are artificially pushing up prices, resulting in a pernicious wealth transfer from the buyers to sellers of these homes." According to AEI, "First-time buyers have accounted for the bulk of the year-over-year rise in the composite National Mortgage Risk Index for home purchase loans since early 2015, reflecting the widening gap between the risk indices for first-time buyers and repeat buyers compared with a year earlier." Risk layering is largely responsible for the increased riskiness of the first-time buyer mortgages. According to the report, 70 percent of first-time buyer mortgages in April 2016 had a combined loan-to-value (CLTV) ratio of 95 percent or higher and 97 percent had a 30-year term. e combination of slow amortization and little money down will likely result in very little home equity for these buyers for many years, barring substantial home price appreciation. In addition, slightly more than one-fifth of first-time buyer loans in April had a FICO score of below 660, which is the traditional definition of subprime mortgages, and nearly 30 percent of them had total debt-to-income ratios higher than 43 percent—the limit set by the Qualified Mortgage rule. According to AEI, two factors that made repeat buyer mortgage less risky were: a much smaller share of repeat buyer mortgages had a CLTV of 95 percent or higher and a much smaller share had a FICO score below 660. The nation's serious delinquency rate as of April 2016, a decline of nearly 22 percent from April 2015's serious delinquency rate. Source: CoreLogic STAT INSIGHT 3.0%

• Cover