Stan Middleman: GSE Reform, Market Corrections and Election Year Impact

Amy Brandt, a Mortgage Media Advisor, sat down with Stan Middleman of Freedom Mortgage to take a closer look at affordable housing, GSE reform, the impact of elections, potential market corrections and much more.

Amy Brandt: Hello, this is Amy Brandt with Mortgage Media here in Austin, Texas at the MBA Annual Convention, and I’m with Stan Middleman, CEO and founder of Freedom Mortgage. I’ve had the pleasure of knowing him for a while. Stan, thanks for taking some time with me today.

Middleman: Nice seeing you again, Amy.

Brandt:  So how has the MBA been for you? Any big takeaways this year? What do you think the buzz is? We always have some certain hot topics in the industry. What do you think is going on this year?

Middleman: I was reading all about [HUD] secretary [Ben]Carson’s comments about bringing the banks back into the HUD space and the FHA. Apparently, that seems like a pretty big deal. I think that the treasury report that came out a couple of weeks ago tied in with this movement, and Brian [Montgomery] was very clear he wanted that to be part of his mission when he got to the FHA, and to be supported by secretary Carson and helping him accomplish that. 

Anything that creates affordability for people in this country to own a home is a big plus. So, the banks being in that business, I don’t know if that’s going to make them really want to do that business, but if it did, it would be good for the people of this country.

Brandt: That’s a big area of lending for Freedom, in the FHA space, and has been for quite some time.

Middleman: It is.

Brandt: So, how do you think the changes that he’s talking about would change anything you do?

Middleman: Well, we’re kind of going to do what we do. I think that from a day-to-day, tactical standpoint, nothing’s going to change. Over time, it may become more competitive. Over time, the banks could have some competitive advantages, and they have some competitive disadvantages that are tied into them. But at the end of the day, it’s good for society for more people to have access to credit. And if the banks provide access to credit for the less fortunate, and people that are challenged economically, and people that want to take advantage of high LTVs in a government sponsored loan, I think, that can only be good.

Brandt: I mean, certainly, FHA is the primary way for someone to get into a home with a low down payment or credit challenges. They’re essentially doing a lot with the sort of affordable housing and lending. The False Claims Act has primarily been the obstacle for the banks. Do you think there’s other obstacles as well?

Middleman: Well, it’s hard to sell somebody that’s fighting to make their mortgage payment on other products. So, the opportunity to cross sell an FHA customer for a bank is not great, and I think that they put a lot of value in wealth management and other opportunities that are more bountiful in a different type of borrower. But, I think that access to credit and the ability for somebody to own a home and have the chance to have skin in the game, and be part of a neighborhood and a community, to own their own home and to have leverage on their personal finances, which is just not generally available to working class society, it’s a really big deal.

And that opportunity is really the value that the FHA brings. If we can get home ownership just a little bit higher … It doesn’t have to be 69 or 70 percent but it would be nice if it was 68 or 67 percent.

Brandt: Right, and it’s hovering pretty low right now. What’s the number?

Middleman: It’s been low. I think it’s been as low as 64 percent. It’s probably starting to sneak back up.

Brandt: Yeah. There’s certain ethnic groups and classes that are even lower than that.

Middleman: Way lower, and they’re the people that need that same opportunity. So, that’s kind of the way I think about it.

Brandt: Do you think that this is also related to some of the things going on with the GSEs, and the talk about GSE reform?

Middleman: Yes.

Brandt: Can we transition to that, or is this a no fly zone?

Middleman: No, that’s fine. At the end of the day, there’s nothing wrong with getting the GSEs out of conservatorship. That’s a worthy endeavor. I don’t think that there’s anything wrong with them being properly capitalized and these are good events. There’s nothing wrong with making good loans, and there’s nothing wrong with the thought of having certain borrowers getting their loans from the FHA rather than from the GSEs. 

The part that we could be more thoughtful around is understanding that these things alone are not going to stop a housing crisis. When supply is tight and property values get bid up, and then building starts because more people in the housing business want to create supply since the profit margin is there, and the supply increases, there’s no mechanism to manage supply and demand.

It’s opportunity. There’s cost and reward. People will take risks and buy homes. They’ll look at their homes and see the opportunity to make money in their homes, and see the value go up. People that would have bought a smaller house might get a bigger house because they’re going to get a bigger percent increase in that value. Some people will speculate on homes that they probably shouldn’t. And you’ll see more fix and flip kind of stuff as the property values rise. 

Then when the correction comes, it could have a significantly negative backlash. And none of the things that we’re doing around housing finance reform will stop the correction. MI companies that are mono-line insurance companies, which only insure people with high LTVs, the properties they’re insuring go down by 20 or 30 percent. You add another 20 percent of the cost for loss mitigation. They’re not going to deny claims. The houses are going to be worthless. They’ll take losses. They’ll get wiped out.

Brandt: I’ve seen this movie.

Middleman: Yeah. It’s predictably repeatable. Anyone that thinks the few steps we’re taking in housing finance reform insulate us from underlying asset valuation correction are just probably wrong.

Brandt: So, what steps?

Middleman: I won’t say they’re definitely wrong, because I could be wrong.

Brandt: What steps could you take? I mean, how can you prevent that?

Middleman:  If you look at the FHA during the last crisis, they survived okay. The reverse mortgages hurt them, but if you took that out of the equation it didn’t really get horribly bad. And the fact that they collect premium from all their customers is a plus. If that customer can’t improve their credit well enough to get a lower cost conforming loan, well, so be it. It makes the fund stronger for those people that pay and their likelihood to abandon their home is not very great.

Their likelihood of being delinquency might go up, but I think what actually happens is if the GSE loans are high LTV loans, and have deteriorating credit, that’s going to create exposure. So, if the GSEs had a somewhat smaller footprint and we forced more people into the FHA, we can better manage the insurance fund. But to do it in a tiered pricing environment that drives up the cost to the borrower is wrong, and I don’t think it’s socially fits what we’re trying to do. We need to socially engineer housing opportunity, and not penalize people for taking advantage of the opportunity of owning their home. That’s important.

Brandt: I do too. So, pushing more towards the FHA in their scheme. Is there another way to do that insurance-wise? If Fannie and Freddie were to continue lending and there were other mechanisms that could be used to help?

Middleman: The other thing, I hope, is that there will be other outside competition. We’re going to see the private-label securitization take hold, but all of those things are going to be more expensive alternatives. If we got more people insured in the FHA, where there are more people paying into the fund, now you have the losses of a few spread over the risks of many and that would make the fund healthier. If it caused the fund to charge a little more insurance at some point in time, or raise the price, and if you built the size of the fund a little bigger, it would be safer. But it would certainly be more reliable than a mono-line, private mortgage insurance company that fails because every customer goes out and they compete in price. So, if you’re competing in price and your reserves, even though higher than in the past,  they still aren’t very high, and your likelihood of surviving a major correction aren’t good. So, I would say it would be the better alternative.

Brandt: So let’s talk … I think you have opinions about this. When do you think-

Middleman: Well you know me, right? I have opinions.

Brandt: I know, it was almost a superfluous statement. When do you think such a correction might occur? What would be the conditions precedent to finally cause such a correction?

Middleman: Well, property values rise, we go into a little bit of a recession, or unemployment rises. That would be interesting. When you see unemployment rise and property values rise, and people trying to leverage their way into a home and they overbuy their home, those are the conditions that would be right for this kind of problem.

Brandt: And rates perhaps?

Middleman: Well, if unemployment goes up rates come down and it just adds fuel to the fire of the property values going up, because now you can buy more house for the same money. Right?

Brandt: Right.

Middleman: And as affordability improves, the cost of the house goes up. And as that cost rises and there’s more supply comes to the market, ultimately you have too much supply and you have all of these homes that are single family rentals. Wouldn’t it be interesting if they became for sale, and wouldn’t that supply potentially force an oversupply in the marketplace tied into a reality of rising property values and improved builder output? I think some of the stuff is there that could come together to cause that kind of event to occur.

Brandt: So, with the current rate environment we’re getting more fuel on the fire, if you will, for the foreseeable future. What do you think about the supply levels right now? How close are we to an oversupply level?

Middleman: Oh, nowhere near it.

Brandt: Yeah. That’s what I thought.

Middleman: There’s a supply shortage, which is going to increase the demand, which will get the prices…

Brandt: The prices.

Middleman: Starting to move. And the more those prices start to move, and we get to a situation where there is some unemployment, and the Fed is forced to reduce interest rates and affordability goes up for those people that are employed, because unemployment’s not going to get way out of hand. That’s when the potential snowballing effect that I described could happen.

Brandt: I mean in a lot of the major metros the timeline to get permits and get houses constructed now is pretty long, so there could be a decent size lag.

Middleman: We’re not there tomorrow. If I had to predict a timeframe, I would look for the middle towards the end of the next decade – 26, 27, 28, 29.

Brandt: This year we all entered … or at least a lot of originators, entered the year thinking it was going to be a tough year, that rates would go up and that originations would be down. We needed a cost cut and of course rates have gone the other direction, and volumes have also gone the other direction, so we’ve seen a surge in volume. How do you think that plays out over the election year next year? Do you think we continue to see volumes up?

Middleman: I think that’s true. For the first time in my career I saw a president react to interest rates two summers before the election. All candidates react to interest rates the summer before the election, and almost all the time you see lower interest rates around the election. I wouldn’t be surprised if I saw that again this time. But I expect between now and then to see a lot of volatility and you’ve seen a lot of volatility. You saw rates go really low and now you’ve seen them bounce back. Even today they’re up. The 10 years in the 180’s after being down to the 140’s,  and 150’s.

We’re going to continue to see volatility, but not big jumps in interest rate, because it’s going to be in their best interest to try and keep the rates down through the election. The question is really unemployment. Will unemployment rise prior to the election? Because that creates a different chain of events than if unemployment rises after the election. If unemployment rises prior to the election, interest rates get lower, but the likelihood of re-election in the existing government group is less. If it happens after the election, I think the likelihood of re-election is better. There’s going to be a great deal of interest in keeping rates low through the election cycle, as there almost always is.

Brandt: There’s so much going into 2020. CEOs planning for what do you do in 2020. You have a lot of things coming up on the regulatory side: uncertainty around elections, rates, unemployment, house prices. How do…?

Middleman: Head on a swivel and pay attention. I mean, you have to pay attention. You have to plan for the best and the worst.

Brandt: Yeah, I guess. How do you do that simultaneously, because mortgage companies inherently are built around capacity for the best?

Middleman: Well, I heard that our business is interest rate sensitive.

Brandt: Really?

Middleman: And if you believe that you’re always preparing for both. If you are of the view that interest rates are going to rise, you probably want to accumulate servicing because the value of that asset will go up. If you’re of the mind that interest rates are going to be flat to lower, you probably want to build your origination capacity. 

I know that there’s been a lot of cost cutting in the prior couple of years and that people are reluctant to take one view or the other. If you are reluctant to create a view, then you better go about the business of being more efficient in your processes and get your costs down. Because if you’re not going to change your capabilities, you better manage your costs more effectively, and figure out how to leverage your cost environment and make your employees more efficient.

Brandt: I would think you need to do that regardless of your view. You, just at some point, need to be thinking about that.

Middleman: That wink says, yes.

Brandt: I hear you, and I happen to know as a partner of Freedom that you guys are doing quite a bit around that. The origination volumes have been fantastic.

Middleman: Yeah, we’ve been a little busy.

Brandt: Yeah, you’ve been busy. I think we’ve almost used up our time. I was supposed to ask you something about your travels so people could know Stan Middleman better.

Middleman: Well, I’m very excited about the coming basketball season, being a 76ers fan. I think we’re going to have a pretty good season this year. Knock on wood, nobody gets hurt. So, I’m going to go to a lot of basketball games. I’m going to spend some time in Florida, I’m going to spend some time in the summer at the beach in New Jersey, and I’m going to work because…

Brandt: I know you’re going to work.

Middleman: This is a busy time and you really need to pay attention. If you’re not paying attention you might find yourself in a problem.

Brandt: I absolutely agree. Thank you so much, Stan. This was awesome. I really enjoyed it. Thanks.

Content has been edited for length and grammar.