Chris Whalen on How to Limit the Damage to the System

Chris Whalen doesn’t hold back when analyzing the government’s actions during this pandemic. Whalen, an investment banker and author and Chairman of Whalen Global Advisors, talked with Mortgage Media’s Eric Souza about a number of the issues facing the residential lending market.

Here are some of Whalen’s comments from their conversation. You can listen to the full interview here.


On the FHFA’s response

We can only really react to their announcements. There have been a couple of things. First and foremost, they indicated that they were only going to make servicers – banks or non-banks – advance four-months’ worth of missed principal and interest payments on mortgages that have gone into forbearance under the CARES Act. The legislation that Congress passed essentially told all Americans that they could skip their mortgage payment. This really was just supposed to be focused on government-insured mortgages, but it has, in fact, become a general announcement of the jubilee for all debtors in America. And you’ve had regulators strong-arming private lenders to provide forbearance as well, even though it’s not legally mandated. Ultimately, the bond holders in auto loans and such, things like that … will pay for it.

It’s been quite an undertaking. This is probably the biggest unfunded-mandate ever passed by the Congress. And the FHFA, I think, which is now led by a conservative friend of mine, Mark Calabria, was somewhat blindsided by this.

… FHFA essentially came out after a lot of yelling and screaming and said, “All right. Fine. You only have to advance four months of forbearance on these loans.” But we’re not quite sure what happens after four months. We’re not sure, for example, if we’re going to be reimbursed.

That was the big announcement out of FHFA. We appreciate the clarity that says that Fannie Mae and Freddie Mac will essentially take over advancing after four months. But I think that it’s going to be a long process, working with the FHFA and with Fannie Mae and Freddie Mac. And I think it causes people in the industry a lot of uncertainty and unease, because we’ve seen this movie before. We’ve seen the GSEs step away from the market. We’ve seen the private mortgage insurers back away from their responsibilities. And I think for both investors and lenders, there’s a lot of questions today about the conventional market, and whether we should be originating product in the conventional market.


Whether or not we should be originating product in conventional market

I think there’s a lot of risk … the thing about government lending, even though it’s more difficult and it certainly requires you to follow the FHA rules very closely in terms of reimbursement and getting properties resolved in the event of foreclosure … at least you know what the cost is going to be.

With the GSE market, you don’t know. If you go back and look at 2008/2009, what happened was the GSEs tried to force the lenders to repurchase a lot of mortgages that should have been covered either by their guarantee or by the private mortgage insurers.

When you see the operational risk looking at you, it kind of gives you pause. The government market, you follow the rules, you do all the steps properly, you get reimbursed. If you look at the posture of the FHFA and compare that to the GSE market, it’s rather striking, the difference.


How private market is being strong-armed

Essentially, regulators in states like California and New York are telling private lenders that they have to offer forbearance. I’ll give you a great example. Ally, auto lender. It’s a bank. And they have been forced to offer 120 days of forbearance on auto loans. Those are not government-insured mortgages. There’s no legal mandate here. But the regulators have made it very clear to a number of lenders that if they don’t play ball, they’re going to be penalized. They’re going to be punished later on through the supervisory process.

We had this breakdown in the rule of law. Which is really … a big concern for people in the mortgage market. Because that’s what we do – we convey property from one person to another. We provide credit so people can buy real estate. And if you’re not going to follow the rules, if you’re going to just say, “Well, this is a difficult time. We’re going to force everybody to take money out of the pockets,” I think overall you’re going to hurt the market.

You can see that in rental properties and commercial real estate today. In general terms, we’re going to be okay. But I really worry about commercial, multi-family. This time around I think there was even more speculative juice in those sectors than there was in resi.

I think that across the board you will see severe impacts in terms of credit. I live in New York City, so if you look at what’s going on here you’ve had literally hundreds of thousands of people leave the city because they have lost their employment. You’ve had many, many young people, in particular, go home to live with Mom and Dad and they’re not paying the rent. I don’t think that’s going to change in the near term. The high-end real estate market in New York, which was already soft, is going to soften a lot more. And I think you’re going to see high levels of loan defaults for bank and non-bank lenders in this space, simply because economics have changed so quickly. If you looked at where we were in February … I wrote a piece for National Mortgage News about how the banks were coming back. And indeed, they were. They were attracted by the spreads and they were starting to do more securitization after nine years of declining volumes from banks in the securitization market. Well, they’re gone now. The big banks have pretty much pulled the plug on correspondent and wholesale. And this week, if you really looked, it’s only the large non-banks who are still buying correspondent. Isn’t that interesting?


Points he wants addressed from director FHFA Director Mark Calabria

The thing that saddens me as a conservative and as somebody who’s watched Mark Calabria’s career for a long time, is I don’t want to see him fail. I don’t want to see someone of his prominence essentially run into a brick wall, which is what’s happened.

I think the obvious thing for the GSEs to have done would be to say to the industry, “Look, this COVID-19 forbearance is something none of us anticipated. We’re going to provide the advancing on these loans. We’re not going to default them. We’re not going to ask you to buy them out of the pool,” which is good. That’s what they should have done. And then director Calabria could have had the two GSEs go to the Fed with the advances and the Fed would have liquified them. They’re triple A credits, they’re in conservatorship, so it’s relatively easy for them to do that.

I think director Calabria rightly says, “Look, they have no money. They have no capital. And I am currently in conservatorship. I’m supposed to be protecting them and reducing their footprint.” But I think he’s forgotten that the GSEs exist to provide liquidity to the market, particularly when the markets are in extremis and when things are bad. That’s why we created Fannie Mae in the first place. But unfortunately, I think there’s a conflict now between the public mission of the GSEs and the fact that we still have some people who think that they’re shareholders of these kind of sort of private, kind of sort of national corporations. The mistake that was made many years ago by the Johnson Administration during the Vietnam War was to pretend to privatize them. The Treasury never “loosed dominion” over the GSEs, to paraphrase Supreme Court Justice Louis Brandeis. The supposed IPO of the GSEs decades ago was “a fraud on its face.”

And so, now instead of jumping into this market, providing liquidity and protecting their asset … the GSEs have stepped back … remember the GSEs, they own these loans. And even though the servicer, who typically sells loans into the GSE market servicing-retained, are the servicers of the loans, the GSEs control the asset. The GSEs own those loans and they are the issuer of the securities. So, this is their asset. And unlike a Ginnie Mae issuer, these guys are really responsible for taking care of these assets. So, I wish that director Calabria would listen to the professionals at Fannie and Freddie. They know what they’re doing. They have protocols for dealing with this stuff. And the reality is that they should advance. They should reimburse their servicers on the forbearance stuff, so that we can get ready for the real battle. And the real battle is going to be defaults.


What needs to be done to stop defaults?

I don’t know that there is much we can do. My gut tells me after I watch bank earnings that the banks are expecting a very, very large credit default event across many different asset classes; not just residential. This is so different from 2008 when we basically had market liquidity problems that were caused by private label mortgages and securities and derivatives, right? This time, it looks more like the mid-1930s where you have broad dislocation in many industries, you have large-scale unemployment. And I think that we have to be prepared for a wave of defaults in one to fours which could be significantly higher than 2008/2009.

The banks, if you use their assets as a benchmark, the maximum charge off on one-to-fours was 2.47%. I think it could easily go up to four or five percent, so that’s twice 2008. And the banks own the best paper, remember. The jumbo market is actually tied to private label for bank jumbos. Then you think conventionals, which peaked around five, six percent defaults in 08/09. Could be higher than that. Could be getting close to double digits. And then government loans may go to double digits; high teens, low 20s.


Forbearance Numbers

We already have some pretty stunning data coming from the lenders directly and also from people like Black Knight. Hopefully, the requests for forbearance are going to start to go down but I’m not sure that’s the case. I think a lot of people paid their mortgages last month because the payment was already in process. They did it. This month, I think you’ve seen a lot more people looking for assistance. And my sense is that households that look for forbearance, that need to ask for it, are going to have a very high propensity to default later on. Let’s say half of them default and half of them cure. That’s a lot of work for the industry.

The industry, if they are being reimbursed properly, will actually make money on this. The servicers, the high-touch servicers who will typically take the flow from the banks are mostly non-banks. These firms will deal with the problem mortgages, they’ll do quite well on it. And obviously, they have to finance all of this but that’s very doable. The banks, too, by the way, are fine. The banks have more capital than they know what to do with. They don’t need to suspend dividends. That’s silly. They’ve already stopped share repurchases, which is worth $120 billion dollars this year for the top 25 banks in terms of capital retention. That’s enough to fund your credit build in terms of reserves, right? So, the system can handle it. It’s okay. It’s just that the human cost is what bothers me.

It’s the dislocation of people and small businesses and communities that is going to go on for months and months. And that worries me because that’s where you get credit events and I also think it ends up making the economy bad for years to come. This economic recovery is going to be an “L.” Because we’ve wiped out a lot of the services sector and it just won’t come back that fast. Think about it in your community. How many small businesses around where you live are going to reopen when they take the controls off in two weeks? This is a much closer parallel to the mid-1930s in historical terms, not 2008.


What we should be focusing on

The key thing is to stop fretting about servicers, generally, and non-banks, in particular. And remember that these are asset-managers. These guys work for the note holder. So ultimately, in private markets, that’s an investor. Pretty clear. And the investors are going to pay. If you miss four payments on your car, the investors are pretty much going to have to just take a loss.

In the government market, these loans are all ultimately guaranteed by the GSEs or Uncle Sam and we’re going to work through it, so that’s not the problem. The problem is how do we try and limit the damage to the system so that we don’t destroy a lot of wealth needlessly and we don’t create long-term unemployment, long-term dislocation in communities? That, to me, is the most important thing.

The industry can handle this. They have to staff up. They have to borrow a lot of money. But that’s what they do. I think the banks, after the initial shock of building reserves, are going to relax a little bit. They’ve certainly tightened in recent days. But I think it’s important for the Fed and the treasury to realize that benevolence gets you a lot more bang for the buck than being miserable. And when Harry Reid is sitting there talking about having states go into bankruptcy he’s missing the point. We don’t want to have the deflation of the 1930s again. We want to try and cut that curve so that we can catch as many businesses as possible and get them going again.

Look at New York City. Look at any major metro area. Just about all of the hospitality industry is flat on its back and this provides a lot of employment to people. The show business here in New York. Forget it. Broadway? It’s done. So, we have to try and figure out how we can move forward as a society and how we can help people who, through no fault of their own, are suddenly right back where a lot of Americans were in 1935. They had lost all their wealth, they had no work and they were standing in a soup line. And we don’t need to see that again.

I think first and foremost, the Fed and the treasury have to jawbone the banks a little bit, make sure that they’re not going to pull back. The greatest damage done by the FHFA and director Calabria in the past several weeks was his incredible comments to the media where he was talking about having non-bank servicers fail and he was going to move the servicing somewhere else. And that consumers would be better off. I couldn’t even believe that this was a conservative saying these things. It was like I was listening to Bernie Sanders. And yet, I think that there’s hostility still towards banks, towards mortgage lenders, going back to the financial crisis. And we really need to put this aside. We need to get everybody pulling together and that means that the banks have to support companies that are solvent. They have to support people who have collateral that’s guaranteed by the United States. There’s no reason why these assets can’t be financed and there’s no reason why we can’t fix all of the forbearance on all of these loans. It’s very doable.


Check out Chris Whalen’s website The Institutional Risk Analyst, and follow him on Twitter.