Net Net: Promoting innovation and managing change
Net Net: Promoting innovation and managing change

Jim Lockhart on "The Wonder Twins of Disaster"


Its the classic jumping of the gun — just when people start uttering the cliched words could they be seeing the "light at the end of the tunnel" in the real estate market, some economic data elongates the tunnel that the real estate market is in.

Personally, I hate jumping to conclusions and I find it funny after the financial crisis so many people still do. I guess they haven't learned; or they're blinded by hope.

I wasn't too surprised when I saw the data that while housing starts jumped 10.5% in August there was a huge disparity between multifamly and new single-family homes. Why? Because I listen to my contacts.

Richard LeFrak who was on Squawk Box not too long ago was telling me how strong the multi-family market was we even had a segment on air about. The trend he was seeing was so strong he acquired three thousand units on the West Coast over the Summer.

Normally the ones with skin in the game are ahead of the curve on trends because lets face it- that's how they make money and are successful.

Now I know not every trend leads to a pot of gold. But with the overall real estate market on a very slow recovery and more and more people foreclosing on their homes it just makes sense that renting would be getting stronger.

So under the backdrop of all of this is the continuation of what will the Government do with Fannie and Freddie. The line in the sand between the elimination of them to the continued nationalization of the wonder twins of economic disaster gets deeper and deeper.

Today there's another hearing in Washington on how to strengthen Federal Housing Finance Agency (FHFA).

So given the news of the "health" of the real estate market and the hearings on what to do with the "wonder twins", I decided to call Jim Lockhart, former Director of FHFA and Chairman of its Oversight Board. Jim also served as the Executive Director of the Pension Benefit Guaranty Corporation.

Jim is a great person to talk to because let's face it, he has experience in dealing with troubled companies.

When Lockhart joined the Office of Federal Housing Enterprise Oversight (OFHEO) before it was renamed FHFA, in May of 2006, Fannie and Freddie were in shambles. They were still recovering from their accounting scandals, had serious deficiencies in their risk managment systems and their debt and MBS of $4.3 trillion blew away the publicly held debt of the US of $4.0 trillion.

With the words "fundamental change" in the GSEs being uttered in Washington I decided to start off with Jim given their monster like size, how does Congress fix them and move forward?

JL: It is a big issue and they represent a half a trillion dollars worth of mortgages. They along with FHA, are the mortgage market so any changes will have to be worked in over time. But I think the clear goal should be not to nationalize them. They need to be turned back into the private sector as far as we can.

My concern is everyone has latched onto, 'we'll just have them issue mortgage backed securities with the full basic credit of the government behind them'. I don't think that is the right decision. I think you'll be relying too much on the regulator and we have seen the regualtors have had problems. So I think we need the market as well and a regulator to be involved in any future secondary mortgage market in this country.

LL: Speaking of regualtors, let's put on your old regulator hat for a moment. In your recent op-ed you did touch on the challenges back when you oversaw Freddie and Fannie. The regulator is only as good as the regulation it enforces. Enforcement is key. You don't need more regulation, you need better regulation.

JL: You need better regulation. You need people who understand the industry and have the tools to regulate. In my day we certainly didn't have all the tools which made it much more difficult.

One has to assume going forward that there will be regulatory tools. My view is the GSE structure doesn't work. And if congress decides to nationalize it I think would be a major mistake.

Having run the Pension Benefit Guaranty Corporation I have seen how government insurance companies have more moral hazzards. We need to figure out a mechanism to bring Fannie and Freddie back into the private sector for as far as you can.

You also need tough regulation. They should have insurance companies basicly backing insurance mortgage back securities with a federal regulator.

LL: Today Kanjorski is holding a hearing on how to strengthen FHA. What needs to be done to do this? How do you make it stronger?

JL: FHA, has expanded dramatically but over time, I think they need to shrink down to what it was really designed for: lower income, first time home buyers who don't have a lot of money to put down.

FHA has gone from 3% to over 30% of the market. I think a decision needs to be made addressing this. There is a role for FHA, they should focus on just that one segment of the market. David Stevens is right on target putting in place more risk management.

LL: You have Representative Hensarling who wants to have Fannie and Freddie eliminated in five years. Is that really feasable?

JL: First of all when anything is done you will have to break it down between new company and old company. So there will be a portion that has to be protected by the senior prefered in Treasuary on a very long term, ongoing basis because the US government has already made that commitment.

So the question is what does the new company look like? I think it would be very hard to go as Bill Gross said it "cold turkey" at this point. If you bring it all back to the private sector that would not be a good idea because number one, the private sector is screwed up pretty badly with their own mortgage backed securities. And number two, people have gotten dependent on the government support.

So I think you need a mechanism that would slowly create an insurance scheme that is fully replaced by the private sector.

LL: But how do you roll in the private sector when the private sector has been almost non-existent in regards to home mortgages?

JL: The private sector would love to come back. But they can not compete with Fannie, Freddie and FHA. At the end of the day we have a subsidized mortgage market in this country and there maybe an increase of mortgage rates if we move towards the private sector. I don't think it will be dramatic but it would be an increase. Maybe that increase would get the private sector to move back in.

LL: A lot of lobbysts argue if it wasn't for the federal guarantee, the 30 year fixed mortgage would not be viable.

You've got Mark Wallis saying the 30 year mortgage is the most sustainable mortgage we have and that if we didn't have the government, it could put it in jeopardy. What do you think about that?

JL: The 30 year mortgage is a pecular animal because it is not seen in that many countries. It is certainly one that is fully pre-payable but is difficult to manage. On the other hand, it is a very safe product for the consumer. So the decision remains if we want to keep it or not.

LL: What I find interesting with the whole Fannie and Freddie story is the disconnect between the single and multifamily homes standards. Multi-family homes had stricter guidelines.

Why didn't the regulator make the companies have one standard?

JL: One of the reasons was because Fannie and Freddie have different programs. Fannie has a program where the originator has skin in the game and keeps part of the risk. In that case it helped.

Freddie on the other hand did not, but their books are slightly better than Fannie. I think the multi-family side had disciplined underwriting. They knew who they were working with, they had strong relationships with the developers and originators. And they did a lot of due diligence.

On the single family side, things were coming in so rapidly, I'm afraid their standards shrank. They were forced to reduce their standards in order to meet the ever increasing affordable housing goals.

LL: What's your outlook looking forward for Fannie and Freddie. How long do you think this will be drawn out in Congress? When will we see something actionable?

JL: A lot will depend on what happens in November. That will have a major impact on the structure of Fannie and Freddie. I think the new Congress will tackle it relatively quickly, but I'm not sure they're going to come up with any answers.

It took GSE reform six or seven years and by the time they got it done, the GSEs were less than 40 days to conservatorship. So my concern is if we have another deadlock. We have some people that want to flat out kill them, and then we have some who want to nationalize them. And if we can find a middle ground that's great.

My hope would be to reduce the amount of risk to the taxpayer, that's where we need to go. I don't think we need to subsidized housing for middle and upper income people like we are now. I'm hopeful Congress will work together on this one and unlike what they did the last time around.

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A Senior Talent Producer at CNBC, and author of "Thriving in the New Economy:Lessons from Today's Top Business Minds."

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