Do GSEs Encourage Defaults? Richmond Fed Might Think So
I did not see this when it originally came out in November but that's OK because it's relevant now.
Richmond Fed on the GSE’s – “They Encourage Defaults”
The Richmond Fed produced a report that provides some useful information on the issue of non-recourse mortgage loans and their default rates. The report includes a State-by-State breakdown of the rules for defaulting.
“For homes appraised at $300,000 to $500,000, borrowers in non-recourse states are 59% more likely to default than borrowers in recourse states. For homes appraised at $500,000 to $750,000, borrowers in non-recourse states are almost twice as likely (100%) to default as borrowers in recourse states while for homes appraised at $750,000 to $1 million, borrowers in non- recourse states are 66% more likely to default.”
California is the largest State that is also a non recourse State. It is also a place where a significant amount of properties are worth >$300k. Given that the anticipated default rate is 70+% greater then in another State it tells you what is happening and what will continue to happen for Cali-jumbo mortgages. It is a black hole. Given this, why would anyone be willing to lend in California?
More importantly, why would we be trying to offer the GSE's an unlimited bailout? Because investors mistakenly believe GSE debt is federally-backed or perhaps because that's how we marketed it when we went trying to sell that crap to China?
The article continues:
Also from the conclusion is the following. It took me a bit to understand the double negatives. When I see words like this I just assume that it is an effort to obfuscate something.
“We cannot reject the hypothesis that recourse does not have an effect on Loans held by the Government Sponsored Enterprises.”
In the body of the paper is a better explanation:
“Recourse does not have a significant impact on the probability of default for mortgages held by a GSE.”
I found that to be a startling observation. What this means is that people will more likely default on a GSE loan than a private lender regardless if they are in recourse or a non-recourse State. This can only be attributable to the following mindset:
“I owe this mortgage to the Feds. Even though they have the right to go after my bank account to pay this off I know they will not. So screw them, I‘m not paying. There is no downside”.
The confirmation for this comes from the Richmond Fed:
“The probability of default by foreclosure increases by 7% for mortgages held by a GSE as compared to the mortgages held by private lenders.”
(find the Richmond Fed piece in question here)
I don't necessarily read their conclusion as such. We're ignoring the fact that GSEs were, up until recently, engaged in the careful marketing of their debt as "as good as government" until the bottom fell out of that whole song and dance. Perhaps - call me crazy. again - the race to securitize GSE mortgages ("as good as government" LOL, still) meant more people who would have defaulted anyway did.