One study of mortgages during the Great Depression found that almost half of urban, owner-occupied homes (on which there was a mortgage) were in default by 1934. The government’s answer was to sponsor the creation of Fannie Mae in 1938 (or as it is really called, the Federal National Mortgage Association), which was, and still is, a private company, notwithstanding the government sponsorship and the official-sounding name. Fannie Mae has made billions by buying or guarantying mortgages issued to homebuyers — and there has long been an “implicit” government backstop behind Fannie Mae, since virtually everyone believes that the U.S. government would feel compelled to bail out Fannie Mae if it could not survive on its own. (Indeed, the company enjoys multi-billion dollar credit privileges with the U.S. Treasury.)
Fast forward to 2009: a year after the federal government imposed a conservatorship over Fannie Mae (and its sister company clone, Freddie Mac), the lending giants are again in the cross-hairs. Due to the lending crisis, the importance of these two companies has become greatly exaggerated in the recent past — since they provide (or guarantee) mortgages for up to 90% of the market, every aspect of their practices has a ripple effect. Thus, we should all be concerned to learn that, not only are their default rates increasing (remember–the taxpayers may eventually be required to make good these losses), but, at the same time, the companies have tightened standards to a point where they may be a factor in killing off what remains of the real estate market.
Many changes to their underwriting standards have been made, but at least two stand out. One is the “70%” rule — Fannie Mae simply won’t back a mortgage in a condo building where less than 70% of the units have been sold. This creates a chicken-and-egg Catch-22 for developers. Outside of Fannie Mae’s limits, virtually no lenders are willing to go — so what do you do if you have a new building that is just now coming online and need to unload the units? The answer up until recently has been seller financing (if possible, and it is increasingly less so as cash and credit evaporate) or cut prices to a level where cash buyers can step in. (This has apparently already happened in Miami– according to a recent piece on NPR, where condo prices have been slashed below $200 per square foot they have been attracting hordes of cash buyers from South America, since that makes a Miami condo cheaper than one in Bogota or Caracas!)
The other rule also has a broad impact, this time on existing condo buildings.
Fannie Mae will no longer provide a loan guaranty if more than 15% of owners are behind on their homeowners association assessments. In normal times, that does not sound so bad. These are not normal times. This lending guideline means the minute a building his the 15% tipping point, no one can sell to a buyer who needs a Fannie Mae/Freddie Mac (a.k.a. conventional) loans. The terms on non-conventional loans can be staggeringly more expensive, if the loan can be had at all — and fixed rates for non Fannie loans are apparently in particularly short supply.
What’s the practical effect of this?
As any real estate agent will tell you, the value of your property is markedly lowered by the reduced financing opportunities because it kills the affordability — which is a key to the real estate recovery. Thus, neighbors who are in financial trouble stop paying assessments (and, ultimately, their mortgages in many cases) and end up beggaring their condo neighbors in a double whammy — first by the reduced market value caused by adding a foreclosure to the marketplace, and second, by preventing potential condo buyers from getting a conventional loan, once the 15% delinquency tipping point is reached in the same complex. The price-chilling effect of hitting the 15% limit can’t be underestimated, and there is hardly a complex in the country that is immune from such a possibility. In fact, the very chance that virtually any complex could eventually hit the limit may make buyers afraid to buy any condo if they are relying on being able to get long term fixed rate financing at a reasonable price.
Commentators are calling for the government to pull out of Fannie Mae/Freddie Mac. One can only hope that, should this happen, there will be some source of reasonably priced financing available to home buyers. If not, the (golden) goose may be cooked.
Photo Credit: John Picken