Welcome to The S-Curve
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The name of the blog, the S-Curve, is a reflection of our logo and the central feature of our prepayment model. S-curves are seen in nature in many phenomenon, from population growth to prepayment and default models. Our first S-curve, in the early 1990s, used the arctangent function, then piece-wise linear functions, and evolved over time to be more complex and vary by FICO, loan size and LTV. This evolution encapsulates both the timeless nature of fundamental relationships and constant innovation to describe them better over time.
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The GSEs as Regulated UtilitiesThoughts
In the spring of 2019, National Association of Realtors® (NAR), together with financial-market experts Susan Wachter (Wharton) and Richard Cooperstein (Andrew Davidson & Co., Inc.) proposed completing the transition of Fannie Mae and Freddie Mac (Enterprises) into market utilities in a publication entitled “A Vision for Enduring Housing Finance Reform.” This work builds on Richard Cooperstein and Andrew Davidson’s 2017 paper, “ Is There a Competitive Equilibrium for the GSEs?”
In NAR’s latest white paper, “GSEs: Their Viability as Public Utilities,” Wachter and Cooperstein expand on several points in their earlier discussion. On January 14, 2021 at 1:30 PM ET, NAR is hosting a webinar open to all interested parties to further explore and discuss these insights.
Why a Utility?
Fannie and Freddie were established by Congress as private companies with a public mission; namely, to support secondary market liquidity and mortgage access at all times, across the entire country, with a special obligation to support underserved markets. The mortgage origination and capital investment markets are highly competitive and efficient, but the guarantor and securitization markets are not. These markets function better with externally imposed standards for quality, consistency, capital adequacy and fairness. Further, scale is required to achieve these goals. These are the characteristics of public utilities.
The common governance structure for utilities is private companies with service obligations and strong regulators that ensure adherence to the mission and to regulate returns. The cost of capital is by far the largest component of the GSE risk fee, so reducing the unsubsidized cost of debt and equity is the most effective way to reduce consumer cost and advance homeownership. Financial theory and 100 years of empirical evidence show that government-granted franchises that operate in limited markets have lower return volatility and thus lower required returns on equity and debt. Indeed, the beta for utility stocks is half that of the S&P 500.
Three requirements for success are: (1) The GSEs curate stable debt markets for interest rate and credit risk and to intermediate most of their risk into these competitive capital markets. (2) A federal backstop on pass-through debt (MBS) and corporate financing for approved activities such as Cash Window operations and non-performing loan buyouts, but not for equity holders or credit risk securities. And (3) A governance structure that balances the tension between regulation, mission and capital markets discipline with a regulator, board, shareholders and management. At this stage, the regulator and operating model are largely in place, it remains to establish a Board that represents shareholders and other constituents, and shareholders.
The S-Curve Archives
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Thoughts
Summary
In 2021, Andrew Davidson & Co. Inc. (AD&Co) proposed a benchmark cohort approach to setting Ability-to-Repay (ATR) Qualified Mortgages (QM) standards. Successful benchmarks based on data are model-free and transparent, and the cohorts must perform consistently in comparison to one another and across time. Our original work used data through the early stages of the pandemic when non-performing loan percentages skyrocketed.
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ThoughtsHow Lowering Capital Costs Affects Higher-Risk Loans
Government-sponsored enterprises (or GSEs) are companies that provide guarantees and financing to originators through the mortgage secondary market. The size and resilience of the GSE secondary market maximizes diversification and liquidity which reduces financial risk and cost of capital. This benefit accrues to conforming borrowers through lower mortgage rates and resiliently available financing.
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ProductsThe release of Andrew Davidson & Co., Inc.’s (AD&Co) new generation of financial engineering tools marks a shift to a new reality; when the traditional benchmark for MBS valuation, the LIBOR/ Swap yield curve, becomes unavailable. Our recent Product Release email informed our readers about the change. In short, our users can:
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ThoughtsFHFA held a listening session for interested parties on its proposed rule on the GSE process for credit scores. The objective is making mortgage underwriting and pricing more accurate and more fair while balancing practical implementation by firms in the mortgage ecosystem. Along with many others, I had the opportunity to provide insights on this proposed rulemaking.
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ThoughtsIn our January 19th blog entitled, A More Equitable Lending System Will Not Be Created by Accident, we described the efforts it will take to overcome not just bias in lending today, but the systemic factors that have limited access to credit in the past and have created an unjust system.
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ThoughtsIn this short blog post I discuss some developments taking place in the flood insurance landscape in the US and look ahead at a few potential directions things could go. I suggest that universal catastrophic flood insurance coverage with a continuation of the introduction of risk-based pricing would be a significant improvement.
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ThoughtsIntroduction
The Government-Sponsored Enterprises (GSEs) entered conservatorship in September 2008. One could view the succeeding thirteen years as a journey back to financial stability with a refined operating model that looks more like a financial utility than a hedge fund. This business model is more compatible with a fair lending mission for a standard-setter that maintains secondary markets under an effective regulator. The GSEs remain the largest part of the housing finance backbone and a resilient funding source during economic stress.
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Thoughts
Around 75% of white American families were homeowners in the first quarter of 2020, according to data from the United States Census Bureau. However, only 44% of Black American families owned their homes at the same time.
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Thoughts
According to a report by the Research Institute for Housing America, climate change risk is rapidly increasing in the housing industry and will continue to demand more attention and regulation in the near future.
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Mortgage market participants are keenly aware that the Federal Reserve has been scaling back its UST and MBS purchases and factoring the outcomes of its actions on stakeholders across markets.