The U.S. Government now has a $16 trillion deficit. On the other hand, it made about $12 billion on the AIG stock sale - congrats. To put those numbers in context, however, the government would have to do an AIG deal every day, seven days a week, for nearly four years in order to erase the current deficit.

As John Steinbeck famously said, the problem with poor Americans is that "they don't believe they're poor, but rather temporarily embarrassed millionaires." Has the housing market been "temporarily" down? One can never overestimate the intelligence of the masses, but the Financial Times reports that "Americans' confidence in the outlook for the housing market has risen and they believe home prices will continue to rise in the next year, according to a new survey by Fannie Mae." Better than believing otherwise, right? "A rising number of people predicted mortgage rates would go up in the next 12 months, up to 40% last month from 36% in July, while those who felt it was a good time to sell property increased to 18 per cent from 16 per cent. The number of people surveyed who predicted house prices would increase remained steady in August at 35%, but was up from 20% a year ago. Americans expect house prices will rise on average by 1.6% in the next year."

The industry continues to wring their collective hands over the guarantee fee increase. (I've been in the biz so long, I remember when there was a "guarantee fee" and a "guarantor fee", depending on the agency.) I received a note from an industry vet, saying, in part, "The biggest fear in our industry right now is not rising rates but that FNMA and FHMLC, already in receivership, have been given a death sentence with no chance of parole. It sadly appears to many of us that, no matter how reformed and beneficial the GSE's are to the health of housing market and our economy in general, they are going to subjected to a slow and painful death. The lethal injections may have already been started."

The note continued. "Case in point, the latest G-fee increase of .125% has already added a full 50 bps to our price on 60 day locks. I have also heard that FNMA that they are also capping the amount of loans that new FNMA approved seller/servicers can send directly to FNMA by capping production at 20x their net worth. So, for example, if we have a net worth of $10 million, we can only sell FNMA $200 million for the entire year. But we just closed nearly $100 million in August alone so we have no choice but to send in loans as a correspondent to the aggregators, and they in turn service the loans, steal our customers, and sell to FNMA without those caps in place as they are an established seller servicer. But wait, the fun doesn't end! With the impending Basel III reserve requirements possibly hitting even the 'too big to fail banks' in the upcoming years, there is a fear that they too will start to shrink their loan balance portfolios. This redirects us to sell loans to the agencies, which have us capped out!"

Here are my thoughts on this.  First, a clarification that the gfee increase may result in approximately 50 basis points difference in price, not rate (using a 4x1 multiple).

Second, FHFA indicated that the gfee increase was intended to help flatten out the price difference between big and small lenders. If the average is 10 basis points, and the large aggregators saw 12, that means to move back to the average, by my simple calculations, plenty of "smaller guys" will see less than 10.

Third, the guarantee fee is intended to cover expected risk inherent in eligible deliveries.  Even at the current gfee levels, it was generally agreed that Fannie & Freddie have been underpricing the risk on eligible loans, with support of the Government and FHFA wanted that to change.  (More on how g-fees are set, and some theories about possible future increases, below.)

As it relates to these repurchases, no one is going to disagree that lender have to be financially able to repurchase ineligible loans. If you don't think monitoring counterparty risk is a huge issue, just ask the CFPB, or Capital One after it paid some hefty fines for exactly that issue. Fannie needs to manage counterparty risk, and one way to do that is by limiting deliveries based on net worth and other factors. The 20:1 ratio you reference, based on net worth, is known to be merely a starting point.

But folks are asking, "How was the delivery limit set?" It appears that Fannie took, as a starting point, the net worth of the company. For newly approved lenders, it is hard to gauge what future deliveries will look like, but for more seasoned lenders, profile of deliveries and any outstanding obligations (such as loans not repurchased) get factored into the limit.  Lenders who have delivered a better book of business to Fannie are rewarded with a higher sales cap.

So what if you don't like the 20x1, or whatever ratio you might have, what can a lender do? Call Fannie Mae and talk with them about it. Another is to (gasp!) keep your earnings in the firm rather than taking them out.  Per the MBA, independent mortgage banks' margins are very good (, so now is a great time to bump up the net worth of the company. Owners pulling out large chunks of capital in order to shield it from potential liabilities down the road may see this strategy backfire with lower delivery limits based on that reduced net worth. Another strategy is to be willing to post collateral as an alternative to increasing net worth.  I've heard that putting some of that liquid net worth into an escrow/custodial account might increase whatever delivery limit is set.

So, don't be afraid to have a conversation with Fannie about your limits. And by the way, with all this talk about Fannie, let's not forget Freddie. My guess is that the FHFA gave both agencies directives, and how Fannie and Freddie implement is up to that particular agency. So watch for Freddie to come out with something similar.

Returning to the g-fee hike, how did the FHFA arrive at that level of increase, and how will increases be determined in the future? The FHFA, looking at Freddie & Fannie's portfolio performance, realized there were performance issues based on maturity, FICO, LTV, and several other factors. Underwriters knew this already, right? Most analysts who follow such things think that the G-Fee hikes should be positive for lower coupon 30 year pools, which will experience the biggest valuation upside. Although the FHFA has not announced full details, the market anticipates fee hikes on weaker credit borrowers, which should increase the price for existing pools so investors liked the news, even if lenders and borrowers did not: investors will hold onto the higher yielding pools longer. (Although just like we saw in March, the market will see a rush of refi's ahead of various investor deadlines, which in turn are based on how long it takes to pool and securitize the loans.)

Returning to the nitty-gritty, the g-fee hikes will reduce cross-subsidization of high risk loans by increasing pricing for loans with maturities greater than 15 years. The cash window will implement these changes for commitments starting on November 1. Differences in g-fees between lenders delivering large volumes to the GSEs and smaller lenders will also be reduced. Folks "in the know" say that separately, the FHFA will also publish a proposal for state level pricing for public input.

But all this still begs the question, "What is a private market g-fee?" Under the Housing and Economic Recovery Act of 2008, the FHFA is required to conduct annual studies of the g-fees charged by the GSEs and submit a report to Congress. The FHFA uses loan level data from the GSEs segmented by product type, LTV, credit score, and size of lender for the purposes of this report. Each agency's proprietary costing model is then used to estimate cost due to guarantee payments and the expected return on capital. "Private money" does not necessarily have access to this data. For F&F, the current and future g-fee is based on the projected g-fee cash inflows: is fee income sufficient to offset the cost involved in guaranteed loans, as well as the required return on capital. Makes sense to me, although one can only guess at the exact "private money gfee."

Traditionally, smaller lenders pay higher g-fees due to the perceived higher cost of doing business with them. MBS hedging costs borne by the GSEs (as smaller lenders are more likely to deliver to the cash window), liquidity disadvantages, higher effect of fixed administrative costs, and higher counterparty risks are included in those costs. And historically larger lenders are also usually able to negotiate down their g-fees: U.S. Bank does not have the same g-fee as Rob's Home Mortgage and Laundromat. But recent reports show that the higher fees charged of smaller lenders are disproportionate to the higher costs. In the future, don't be surprised if the agencies come out with either an entirely different structure, or take the current structure and use more loan-level price attributes to set the g-fees to better model the risk.

By the way, yesterday the commentary mentioned the new rep & warrant framework that clarifies future liabilities (read: reasons lenders are asked to buyback loans). Here is the actual announcement.

Turning to the temporal markets, Tuesday saw little change in prices (the 10-yr was down about .125 and closed at 1.70% and agency MBS prices were worse about 1/16 in price) on less-than average volume. Chatter in the press focused on the 3-yr auction (just fine), today's $21 billion 10-yr auction, and miscellaneous news from Europe. Today begins one of the periodic Federal Open Market Committee meetings ("ok...who took the last jelly glazed...Ben wanted it!") and the market seems to be positioning for QE3 information from the Fed later this week: mortgage pricing is doing better than Treasury pricing.

In the early going, unfortunately, rates have edged higher: the 10-yr has crept up to 1.74% and MBS prices are worse by .125-.250.

An American tourist in London decides to skip his tour group and explore the city on his own.
He wanders around, seeing the sights, and occasionally stopping at a quaint pub to soak up the local culture, chat with the lads, and have a pint of the Local Favorite.
After a while, he finds himself in a very high class neighborhood - big, stately residences - no pubs, no stores, no restaurants, and worst of all... NO PUBLIC RESTROOMS.
He really, really has to go, after all those Brews.
He finds a narrow side street, with high walls surrounding the adjacent buildings and decides to use the wall to solve his problem.
As he is unzipping, he is tapped on the shoulder by a London Bobbie, who says, "Sir, you simply cannot do that here, you know."
"I'm very sorry, officer," replies the American, "but I really, really HAVE TO GO, and I just can't find a public restroom."
"Ah, yes," said the Bobbie "Just follow me." He leads him to a back "delivery alley," then along a wall to a gate, which he opens. "In there," points the Bobbie. "Whiz away... anywhere you want."
The fellow enters and finds himself in the most beautiful garden he has ever seen.
Manicured grass lawns, statuary, fountains, sculptured hedges, and huge beds of gorgeous flowers, all in perfect bloom.
Since he has the cop's blessing, he zips down and unburdens himself and is greatly relieved.
As he goes back thru the gate, he says to the Bobbie, "That was really decent of you - is that "English Hospitality?"
"No," replied the Bobbie, with a satisfied smile on his face, "that is the German Embassy."