Bank of America this week announced it is severely cutting back sales of loans to Fannie Mae. The move is part of Bank of America's (BAC) ongoing efforts to undo the damage of its ill-fated acquisition of Countrywide Financial in 2008, but could have broader implications if other big banks follow suit.
To date, Bank of America has paid Fannie Mae and Freddie Mac $2.6 billion to settle demands from the GSEs that the bank buy back mortgages that have gone sour, or were wrongly underwritten. Bank of America cited "ongoing differences" with Fannie Mae over these repurchase claims as a rationale for severely curtailing its dealings with Fannie. In December, the bank underwrote just $3.5 billion of loans backed by Fannie, Freddie or Ginnie Mae vs. $21.9 billion in December 2010, The WSJ reports.
The practical implications of this decision is it will be harder for consumers to get a home loan from Bank of America, which has already stopped buying loans from third-party mortgage lenders. Citigroup is moving in the same direction, according to a source in the mortgage industry. While other banks -- like Wells Fargo (WFC), Sun Trust (STI), BB&T (BBT) and US Bancorp (USB)-- are stepping into the void, the decisions by BofA and Citi (C) are exacerbating the problems many Americans are having trying to secure a loan, even those with good credit scores and money for down payments. (See: Getting a Mortgage Shouldn't Be This Hard: Housing Finance Gets 'Taken to Task')
In Search of...Life Beyond Fannie & Freddie
By ending its activity in the so-called correspondent lending channel, Bank of America is effectively saying it will only underwrite mortgages that are originated in house. By stopping the sale of most loans to Fannie, the bank will either be forced to hold those loans in its portfolio or seek an alternative buyer.
Since 2008, the private secondary market for mortgage loans has effectively dried up. Fannie Mae, Freddie Mac, FHA and other government-sponsored enterprises back more than 90% of all home loans originated since the crisis.
Earlier this month, Treasury Secretary Tim Geithner laid out a plan to significantly reduce the government's role in the mortgage market, based on three options, as The NY Times reports:
- Eliminate any government guarantee for middle-class mortgages.
- The government would only back loans during times of financial distress.
- The government still would only guarantee mortgages if lenders first purchase a guarantee from a private insurer.
Bank of America's decision to stop selling loans to Fannie appears to be the case of one firm being fed up dealing with Uncle Sam's minions and the story may end here. Still, BofA may have unwittingly opened the window to a fourth, private-sector solution.
If Bank of America is able to successfully originate loans and find a private secondary market to sell them into, other banks may want of a piece of the action too. Private firms like Goldman Sachs (GS), as well as hedge fund and private equity investors might be interested in creating an alternative secondary market, if the price is right, of course. This could take years to develop, if it ever gets off the ground, but Geithner put a 5-to-7 year timetable on his exit plan so there is plenty of time for the private market to test the economics of such a scenario.
Ultimately, a private-based secondary market will almost certainly mean higher fees and higher mortgage rates for consumers, and banks will almost certainly continue to tighten lending standards in the hypothetical post-Fannie era. Many will argue that'll be money well spent if we can really kick the GSE habit.
There's a price to be paid for unwinding the current system and, one way or another, U.S. taxpayers -- the ones who bailed out the big banks and are still on the hook for Fannie and Freddie -- will almost certainly end up with the bill.