Q&A with Jim Lockhart
The former regulator of Fannie Mae and Freddie Mac thinks it’s time for Congress to address taking the two players out of conservatorship. He also thinks the companies “overdid it” with their repurchase demands in recent years. Read his other comments on the current state of the market.
By Robert Stowe England
James B. Lockhart III has served since 2009 as vice chairman of WL Ross & Co. LLC, a New York-based subsidiary of Invesco Ltd., Atlanta. Previously, from 2006 to 2009, he was director of the Federal Housing Finance Agency (FHFA) and its predecessor agency.
Lockhart was at the helm of the newly named FHFA in September 2008 when the federal government put Fannie Mae and Freddie Mac into conservatorship at the onset of the financial crisis.
From 2002 to 2006, Lockhart was deputy commissioner and chief operating officer of the Social Security Administration, where he promoted the Bush administration’s Social Security reform. He succeeded in getting the Supplemental Security Income (SSI) program, the nation’s largest cash-assistance welfare program, removed from the high-risk list of the U.S. Government Accountability Office (GAO).
Lockhart also served as executive director of the Pension Benefit Guaranty Corporation under President George H.W. Bush. When Lockhart headed the agency, it faced major airline and steel company bankruptcies.
In 1997 Lockhart co-founded Greenwich, Connecticut-based NetRisk Inc., a risk-management software and consulting firm. Prior to that he was senior vice president of finance at National Reinsurance Corporation and managing director at Smith Barney’s Investment Banking group. Lockhart holds a Master of Business Administration degree from Harvard University and a bachelor’s degree from Yale University.
Mortgage Banking caught up with Lockhart at WL Ross in New York recently to ask him about his views on the current state and future outlook for the mortgage market and mortgage reform.
Q: What is the fallout from the Federal Reserve’s decision to end quantitative easing or QE--a program under which at the Fed was buying $1 trillion a year at its peak in Treasuries and mortgage-backed securities [MBS]?
A: Well, I think from the mortgage market standpoint, it will probably have a minor impact--higher mortgage rates over time. It’s probably a good thing at this point this far into the recovery that QE does come to an end. From the economy’s standpoint, you could probably argue it will be a minor negative. But, on the other hand, it’s timely to get rid of the artificial stimulation. The Fed is going to continue to repurchase bonds and keep their portfolio at a very high level. So, I don’t think it will have a major impact.
Q: Do you think that the MBS purchases by the Fed will be judged by history as a successful government initiative?
A: Yes. I think it made sense, especially at the beginning. Both the Fed and the Treasury at the beginning were buying mortgage-backed securities. I thought that was an important thing to do to show confidence in the marketplace and also bring those spreads down that had gotten quite large. Historically, yes, I think it will make sense. Obviously QE III was a whole new size of that. But again, I think it helped the mortgage market recover.
Q: There have been a number of efforts through legislation and regulation to address the fallout from the crisis, but it seems we haven’t addressed some important matters that we need to address.
A: I agree. The big 900-pound gorilla, Fannie Mae and Freddie Mac, has not been addressed. They were addressed at the beginning by putting them into conservatorship. I think this conservatorship has worked. But at this point we need to address the future of Fannie and Freddie.
While obviously the low interest rates [from the Fed’s intervention] have helped the market, there has been some countervailing forces. Certainly all the regulatory burden that has been put on through [the Dodd-Frank Wall Street Reform and Consumer Protection Act] has slowed the recovery of the mortgage market somewhat. But overall we’re making progress. We’re muddling through.
You can worry somewhat about homeownership rates falling and I think it’s right to worry. What the right level for homeownership is, I’m not quite sure at this point. Affordability is somewhat tough.
Certainly all the lawsuits out there--the FHFA’s, Fannie’s and Freddie’s putbacks, the various settlements with the Securities and Exchange Commission and the attorneys general--have all sort of been adding a lot of uncertainty to the mortgage market, which has slowed down the recovery, in my mind.
Q: Where do you see the most progress being made in restoring housing finance to its former health? What success has there been?
A: If you define restoring it to health to include a healthy private sector, obviously we’ve been very slow at that. Obviously Fannie and Freddie have played an incredibly big role, as have FHA [the Federal Housing Administration], VA [Department of Veterans Affairs] and Ginnie Mae. But where we have fallen short, in my mind, is the government involvement is too large.
We’re starting to see some private-sector involvement, but it’s slow. We’ve been seeing more mortgage-backed securities issued lately. Some of the risk-sharing transactions Fannie and Freddie have done are a step in the right direction. But we need to restore the private-sector residential mortgage-backed securities [RMBS] market. It’s miniscule at this point.
Q: Has portfolio lending in the private sector helped the mortgage market?
A: Really, at the moment most all mortgages originated, including the ones our companies do, are going to Fannie and Freddie. The only ones that are not are the jumbos. There’s a good appetite now from banks and we’re starting to see it for jumbos from mortgage-backed securities investors. So that’s a start in the right direction.
The non-QM [non-Qualified Mortgage] product is starting to be originated, but there’s a lot more talk about it than actual originations and sales of the non-QM product. We’ve got a ways to go. To me, it’s hard to make significant progress getting the private sector back in until Congress decides what it wants to do with Fannie and Freddie.
Q: What do you think they should do?
A: I think the Senate bill [sponsored by former Senate Banking Committee Chairman Tim Johnson, D-South Dakota; and Sen. Mike Crapo, R-Idaho, the committee’s former ranking member] was certainly a step in the right direction, in my mind. I don’t think you can get the government out of the mortgage market. It’s in the market in such a big way. You can cut it back and make it more of a catastrophic reinsurer than what it is now, effectively a primary insurer of the mortgage market. The Federal Mortgage Insurance Corporation in the Senate bill makes some sense to me.
There’s a lot of expertise at Fannie and Freddie. I don’t think you should just shut them down, but reconstitute them in a different way with potentially some of the same people as private-sector companies.
Q: The idea in the Johnson-Crapo bill is to have a lot of private-sector originators. Where would a reconstituted Fannie and Freddie fit in? Would they still be purchasing mortgages?
A: Fannie and Freddie could be packagers, just like the private sector. They would purchase the mortgages and package them up, and other companies can do that. If it’s Fannie and Freddie, they should be a purely private-sector company. They shouldn’t have a charter from the government. They should be basically reconstituted as new companies.
Q: And that would preserve the expertise at Fannie and Freddie?
A: I have got to give them credit. Whoever thought they would still be in conservatorship six years after we put them in? The boards and the management team have done a very good job of holding it all together in my mind. I’ve been impressed with what the CEOs are doing, the board as well, and certainly my old agency, the FHFA.
Q: The FHFA made a decision recently about allowing 3 percent down-payment mortgages and Fannie Mae has already offered some details on what it might purchase. What do you think about having Fannie and Freddie get back into very low-down-payment mortgages?
A: I was never a real fan of 3 percent down-payment mortgages. If FHA and the government want to do them--they’re now 3.5 percent down mortgages--that’s fine. I think it should only be done if there is very, very careful underwriting and very, very careful controls. I mean, if you have 3 percent down and you want to sell your house, even at the same price you bought it at, you’re underwater because you have to pay a sales commission. It’s not a product that builds equity, in my mind, especially if it has a 30-year amortization schedule. And what I would like to see is people rebuild equity in houses--not just from price appreciation but also from amortizing their mortgages.
Q: The FHFA has recently reached an agreement with lenders that sell mortgages to Fannie and Freddie that would limit the extent to which the agencies can require lenders to buy back the mortgages. What do you make of this?
A: I think the pendulum has swung pretty dramatically. Back in 2006 and 2007, Fannie and Freddie were afraid to put back mortgages to Countrywide [Home Loans]--especially Fannie--because they didn’t want to upset their major customer. It then went just totally the opposite situation and they were putting back mortgages for minor errors. I don’t think that helped the mortgage market. I thought they overdid it.
It’s very helpful to spell out the rules of the game as clearly as one can and ensure that the underwriting that’s done at the time the mortgage is originated is done properly and accurately. But to second-guess because something happened three years down the road is detrimental to the mortgage market. I am happy they are continuing to try to refine those rules and make sure people understand what they are. I think they should be applied consistently.
Q: You were talking earlier about the private RMBS market. Recently the regulators issued the final 5 percent risk-retention rule. Will that help at all?
A: I think spelling out the rules will help. Yes. The other thing that will help is we have to make the securities much more transparent than they were in the past, and have all the information there for the investors so that they know what the underlying mortgages are. You know there’s been a series of institutional groups that have come together to spell out the rules. The American Securitization Forum [ASF] and Securities Industry and Financial Markets Association [SIFMA] have both set out rules, and I think that’s a start.
The issue in my mind is that many investors have been pretty stung by private-label mortgage-backed securities, and it will take a while for them to really understand that there is real transparency. Some people have suggested we almost need some form of new trustee to actually do some things that the trustees didn’t do in the past, which is actually look at the underlying mortgages and spell out what the rules of the road are--and I think that will help get the investors back.
Q: Higher guarantee fees [g-fees] for Fannie and Freddie securities could help revive the private market, but those have now been put on hold. What do you make of that?
A: There’s a tension here between trying to promote the housing market short term and trying to find a long-term solution to get the government out. There’s been a back and forth. [Former FHFA Acting Director] Ed DeMarco was a strong believer in increasing the g-fees as a way of helping get the private sector back. Again, the ideal solution is for Congress to act.
Q: Are you at all hopeful that Congress will act now that we have a Republican Senate to work with the Republican House so they can all get on the same page and make mortgage reform a priority?
A: I am hopeful, but I just don’t know whether or not they will. I think it will be very useful for the House and Senate Republicans to try and agree on a common solution. I think certainly the bills in the House versus the bills in the Senate are quite different. Hopefully they can find some common ground.
Certainly this administration has talked about redoing the mortgage market, and if they could come up with a good bill in the House and the Senate, it would be hard for this president to veto it. So, I’m hopeful they can work together--the House and Senate--to come up with a bill that slowly, and it will have to be slowly, reduces the government’s role in the mortgage market in this country.
Q: What is your favorite book from the financial crisis?
A: I guess it would have to be [Former Treasury Secretary] Hank Paulson’s book, On the Brink. Mainly because Fannie and Freddie didn’t really cause the world to blow up, he spent less time talking about what we did. We worked closely with him and [former Federal Reserve Chairman] Ben Bernanke on the conservatorship, and that book covered it well. Of course, your book, [Black Box Casino: How Wall Street’s Risky Shadow Banking Crashed Global Finance], was excellent. Too Big to Fail [by Andrew Ross Sorkin] was also a good and comprehensive book.
Q: What are the challenges you face now in your current position as vice chairman of WL Ross?
A: I run the financial services side for WL Ross and we’ve been very, very active investors in financial services over the last five years or so--or even before I came here, the last six years. We’ve had three different major themes.
One theme is community banks--giving them capital and management to grow. We lost in this country probably over 2,000 banks in the crisis, but we think the idea of a strong community bank makes sense for those in the community. But they have to grow to a size where they have the capability to put up with all the compliance costs that have been saddled on all our banks. So that’s one of our themes, growing a series of community banks.
And we’ve done Bank of the Cascades [Bend, Oregon] and Talmer Bank and Trust [Troy, Michigan]. They’ve actually been extremely active. They’ve done four or five FDIC [Federal Deposit Insurance Corporation] deals and bought banks out from bankrupt bank holding companies. And Sun National Bank in Vineland, New Jersey, and Amalgamated Bank, which is a labor union bank, in New York City. We also did BankUnited [Miami Lakes, Florida], which is one of the first FDIC deals. So, we’re very active in the community bank space.
[As for the second theme], needless to say, we’ve been very active in the mortgage space both here and in Europe. We invested in and grew American Home Mortgage Servicing Co., which changed its name to Homeward Residential Holdings LLC and was eventually sold to Ocwen Loan Servicing LLC, West Palm Beach, Florida. We [WL Ross & Co. and Ranieri Real Estate Partners LP, New York] bought from Deutsche Bank their multifamily originator [Deutsche Bank Berkshire Mortgage, Boston], and renamed it Berkeley Point Capital. It was an originator for Fannie and Freddie and the FHA. And that was again a theme--the government was dominating the mortgage market, both the single-family and the multifamily.
We are also investors in a company called Capital Markets Cooperative, [Ponte Vedra Beach, Florida], which deals with 170 or so smaller mortgage banks, helps them hedge their mortgages and then helps them sell them to Fannie, Freddie, Wells Fargo [and others]. And that’s been a growing business.
And then again more recently, we’ve been an investor in Shellpoint Mortgage Servicing [Greenville, South Carolina], a mortgage originator, both retail and wholesale, and a servicer that has been in the jumbo space and is now just entering the non-QM market.
In the U.S. at this point, frankly, we’ve started to sell some of our positions as the world has recovered.
In Europe we invested in Bank of Ireland, which was almost being taken over by the government, and that was a very successful investment. As you know, we sold out [some of our holdings] in the U.K. in Virgin Money, [which completed an initial public offering in November 2014]. It was a small bank when we invested in it. Our idea was that government was going to be selling some of the assets they had taken over and we invested in Northern Rock through Virgin Money, and that has been successful.
Our third theme has to be with European banks. Europe is behind in fixing their financial system, and certainly some of the countries are much [further] behind. And we’ve looked at them again as opportunities to back good, strong management teams, giving them the capital to grow and, in some cases, like our banks in the United States, clean out their non-performing assets portfolio. So it’s been a very active time. There are certainly lots of challenges out there at this point still, as I said, especially in Europe.
Q: A London banking analyst recently told me that he believes the only reason the 30-year fixed-rate mortgage exists in the United States is that it can be easily funded by excess savings in Asia, especially Japan and China. Is he right?
A: Well, the 30-year fixed-rate mortgage is sacrosanct, but it’s very unusual anywhere else but the United States. It certainly has a lot of optionality built into it that makes it harder for investors to buy, as you know. Some people argue that’s really why Fannie and Freddie exist--to support the 30-year fixed mortgage market. We’re seeing occasionally banks these days buy 30-year fixed-rate mortgages. I think that’s a little dangerous and certainly none of our banks are doing it. In my mind, there’s no natural financial institution that a 30-year fixed makes a lot of sense for at this point. MB
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