Opportunity and Risk

Ted Tozer and Dave Stevens talk GSE reform, challenges facing Ginnie Mae and the always present need for liquidity.

With GSE reform a hot and pressing topic — what with the GAO calling for Congress to end the conservatorship of Fannie Mae and Freddie Mac, and various administration officials saying plans are being formulated to do just that — there is opportunity for true, positive change to benefit all parties. But there’s also some big risk involved.

“It’s an opportunity to possibly streamline the industry more by doing some things to enable Fannie and Freddie and also other guarantors, groups to bring some innovation into the system,” said Ted Tozer. “But also, it’s a risk in the fact that the system is so streamlined and so operational.” Losing some of the efficiency of the current system — let alone the explicit government guarantee for bondholders that they’ll get paid regularly — can make the GSEs less attractive to investors.

That’s one of multiple topics Tozer — a mortgage, banking and securities industries veteran whose impressive resume includes seven years as president of Ginnie Mae — addressed during a conversation with Mortgage Media’s Dave Stevens. Others included the challenges facing Ginnie Mae, the impact of credit policy changes, and opportunities facing the housing market.

Tozer, currently a senior fellow at the Milken Institute’s Center for Financial Markets, also was senior vice president of capital markets at National City Mortgage Company for more than 25 years, and has been a member of the National Lender Advisory Boards of Fannie Mae and Freddie Mac.

So what would happen if the GSEs were released from conservatorship without Congress doing anything to maintain an explicit guarantee? Would the investment community — especially foreign investors — still consider the guarantee to be as good as it is right now?

There would be an impact, Tozer said. From his experience in dealing with foreign investors, he said, those who solidly knew the housing market would be more willing to go the Fannie and Freddie route — they know the politics, that in a default, “you’d have to bail them out.” Those who had never lived or worked in the US were a bit more skittish: “I think they just really want to only own interest risk, and do not want any credit risk.” He said he didn’t find one Japanese organization that would invest in Fannie and Freddie. And some of the formerly biggest foreign investors in Fannie and Freddie aren’t in the mortgage market now — their economies have changed to the point where they don’t have as much money to invest in mortgages. Making the outcome more uncertain by changing the terms of the guarantee probably won’t help matters from that perspective. Then again, for some investors, “yields go up, people get greedy, and they may decide just to give it a shot.” But not all or even necessarily most.

And from a lender perspective, working with Fannie Mae or Freddie Mac or going through Ginnie Mae offers a more streamlined, efficient process than, say, private label securities.

As Stevens noted, regarding GSE reform: “Be careful what you ask for here — because those efficiencies are desperately needed and the disruption could be significant.”


Ginnie Mae performs two basic functions, Tozer notes. For one, it administers the government guarantee: Issuers create mortgage-backed securities, and Ginnie wraps them — and guarantees the bond holders that the payments will come through regardless of the borrower’s status (current or delinquent). Second, it runs the common securitization platform, ensuring all issuers get equal access to the capital markets — you get the exact same execution on your bonds, the exact same format, whether you’re a tiny community lender or a big one like Bank of America or Chase.

The recent 35-day government shutdown highlighted an aspect of Ginnie Mae’s structure and funding that’s “really bizarre,” Tozer noted: “It’s not a normal government organization in the fact that all expenses, except for personnel, are not appropriated through Congress. So for example, government’s shut down, Ginnie Mae’s NOT shut down — except for, it can’t pay its staff.”

That’s a big “except,” though an investor may not necessarily have noticed much of a difference, since Ginnie contracts out running the data center, maintaining hardware and software, running the issuer support desk, etc. If you’re an investor, if you’re issuing Ginnie Mae securities — the payments weren’t affected, so you may not have noticed a difference. But the problem is, what makes Ginnie Mae staff essential, what isn’t turned over to contractors, is maintaining the oversight over the government guarantee, doing the reviews of the agreements and transactions to make sure they’re financially solid. During the shutdown, that wasn’t happening. And were a crisis to hit, Ginnie would not have been equipped to deal with it in the shutdown.

“Ginnie Mae is able to have a technology on its platform that’s very sophisticated. If not the most, it’s one of the most sophisticated scrutinization platforms in the world. It’s 21st century technology, it’s all in the cloud, it’s all client server-based, because again, it doesn’t have to wait for Congress to appropriate any money. Not like FHA that’s begging for money for technology,” Tozer remarked. “Ginnie Mae just has to have its budget approved by OMB when it comes to those functions and the money’s available. So it really is an interesting issue, where we really have a 21st century technology, and 21st century platform, but then you’re left hobbled with staff who really can’t be paid appropriately and really can’t be dealt with properly from the standpoint of getting the skills because it’s appropriated.”

Another issue: A majority, about 70 percent, of new issues through Ginnie Mae are being done by non-depositories — which have their advantages, but some serious disadvantages, specifically, access to liquidity.

“I think the non-depositories do a great job when it comes to servicing, doing their jobs and so forth,” he said. “My biggest concern is just the fact that the non-depositories by definition don’t have as many tools available to them as financial institutions to raise funds in the time of a liquidity crisis, when they’re having basically a run.

“What if all of a sudden the non-depositories lines of credit were reduced or eliminated? … They don’t have the Federal Reserve bank to go to replace their lines of credit. Which means that they’re more susceptible to liquidity crisis, and that’s a concern that I have. It’s never been an issue about their management or their ability to do the job. It’s just the structure — they just don’t have all the same tools the depository has in their tool kit to deal with an economic downturn.”

Even when the borrower isn’t paying, the servicer is still obligated to ensure the bondholder all the required payments — principal and interest. If the issuer doesn’t make the payment, Tozer noted, that’s where Ginnie Mae’s guarantee kicks in — it would shut down that organization’s government lending and move the servicing to another organization that could meet the obligations.

Which raises the specter of Taylor, Bean & Whitaker. They were once a top-10 wholesale mortgage lending firm, and the fifth largest issuer of securities through Ginnie Mae. They ceased operations in 2009 after an FBI raid and being suspended by the FHA from issuing FHA mortgage loans and mortgage-backed securities. (The majority owner was convicted on several fraud charges — essentially the firm overdrew its account with Colonial BancGroup by several million dollars and sold them $1 billion in mortgages it didn’t own.)

Bean’s problem essentially came down to — once again — the need for liquidity, Tozer noted. Food for thought, considering the non-depositories — with their susceptibility to liquidity issues Tozer spoke of — doing the majority of issues these days.

Taylor, Bean was a fraud, brought on by their attempts to stay alive from a liquidity perspective, Tozer said.

“The problem with Taylor, Bean was, they had bottom-fed the FHA business for a number of years prior to the crisis. So when the crisis hit … there were 15, 16 percent delinquencies. Which meant the amount of cash that they had to come up with to service their Ginnie Mae bonds was astronomical,” Tozer said. “Well, at that point they’re playing games. They started double-pledging their loans to warehouse banks to get cash, they were doing all kinds of things to stay alive. … It was a fraud, but it was a fraud because they ran out of cash. They literally could not service their portfolio because of the severity of the delinquencies, because they had made a business of buying low-credit-score FHA loans in 2006-07, and then when 2008 hit, they couldn’t stay alive.”

Back to challenges facing Ginnie Mae, there’s always a challenge when there are changes in credit policy. The challenge is not based on loan losses but the value of the Ginnie Mae MBS. An example of a change that was poorly timed from Ginnie’s perspective, Tozer said, was when the Obama administration cut the mortgage insurance premium. To get the lower premium, a borrower need to refinance — “so all of a sudden, refinancings went crazy. And all of a sudden investors lost hundreds of millions, billions of dollars in value overnight because of the speed of the prepayments that occurred.” (He knew of one institutional investor who lost a billion dollars in one day.) “So that was my biggest challenge dealing with the credit policy — because achieving its underlying speed of the underlying collateral, you can have a devastating effect on investors.” Which in turn can hit borrowers by driving up interest rates — investors would want a higher yield to compensate for their risk.


Finally, when asked about opportunities and risks he sees on the near horizon, Tozer mentioned — in addition to the positive and negative fallout from any changes in the GSEs — the good news and bad news about the housing market that comes from the millennial demographic.

“We have a situation where the housing market should be relatively strong as far as a good buying market, as the millennials move into their prime buying situation — now that, you know, they’re getting married, having children and so forth. So from that perspective I look for a lot of opportunities,” he said.

However, he noted, “The challenges that I see right now are that we really are at a real supply issue of being able to get housing adequate to cover the millennials because the wave is so large that’s coming in.” And the financing needs to be smart and well planned: “What’s fearful is making sure that we are putting people in sustainable-type situations versus this idea of just trying to get them into a home. I think that’s probably the biggest challenge.”