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Ed DeMarco’s Fight Against Banks Over Repurchases

I think I’ve established that I disagree with Ed DeMarco’s position on principal reductions. And under his oversight, Fannie Mae and Freddie Mac have consistently tried to evade transfer taxes to local governments, and employed foreclosure mill law firms that used falsified documents in court. It’s not a good record.

However, where DeMarco has done good work, in his role as a conservator for taxpayers on the GSEs, is with forcing banks to take back bad mortgages. Known as repurchases, this occurs when the purchasers find that the mortgages were sold with misrepresentations that violate prescribed underwriting guidelines for sale. That triggers agreements in the contracts that force the originator to buy them back. And Fannie and Freddie have been aggressive in this area under DeMarco’s oversight leadership. In fact, they plan to ramp it up more:

Government-owned Fannie Mae and Freddie Mac are stepping up efforts to find bad home loans that they can force mortgage lenders to buy back from them, providing an increasingly bigger headache to banks.

The government-controlled companies are squabbling with banks over who should bear the burden of losses from the housing crunch, in particular loans made between 2005 and 2008, when the market was at its frothiest.

Fannie Mae and Freddie Mac’s efforts will translate to higher mortgage losses for banks in the coming quarters. But the end of the fighting may be in sight. Fannie Mae, the larger of the two finance companies, is more than halfway through its review of loans to try to sell back to banks and is mainly focusing on that four-year period, a source familiar with the matter said.

Obviously, with lending standards tightening, this isn’t the kind of thing that will go on forever. But the GSEs’ ability to force repurchases should show how horrifying the market was in the bubble years. Just in the second quarter of this year, Fannie Mae requested that banks buy back $14.6 billion in loans. And this is after years of repurchases. And DeMarco has sued 17 banks over their lack of response on repurchases

The banks think Fannie and Freddie are being technical sticklers for detail. But this is of course at the heart of mortgage origination. It’s ALL about details. And it’s about time that a government regulator dives into the weeds when dealing with the banks. Bank of America has retaliated by stopping lending of most of its loans to Fannie Mae. But Fannie Mae turned a big profit last quarter, so this isn’t really affecting them.

The GSEs aren’t the only entity that banks have to contend with on repurchases; bond insurers and investors have also stepped up to some degree to ask for them. But Fannie and Freddie have been the most effective because they’ve been the most diligent. And this has a salutary effect; considering that Fannie and Freddie are the only entities buying mortgages on the secondary market at this point, this forces strong underwriting guidelines and will help prevent the kind of origination abuses we saw in the bubble years. That may mean that we don’t get another housing bubble with a rapid run-up in prices. Well, good.

DeMarco has played a decent role in this. He put a stop to broad repurchase settlements for pennies on the dollar, and as a result, Fannie and Freddie are going loan by loan with the banks. That maximizes the potential payback for taxpayers. In addition, DeMarco plans to institute new guidelines that would have the GSEs review the underwriting on the loans at the time of sale, before purchase, to prevent mass repurchases in the future. This also will reduce the possibility of bad underwriting upending the system.

So when I see all these calls for firing Ed DeMarco, I always temper my response, because nobody focuses much on successes like this repurchase policy. Ed DeMarco is one of the few federal regulators actually sticking it to the banks. Being $188 billion in the hole and needing to find ways to pay back the government will have that effect, to be sure. But being a steward of taxpayer dollars isn’t always a bad thing.

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David Dayen

David Dayen

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