Freddie Mac Tightens Standards By VIKAS BAJAJ Published: February 28, 2007 http://www.nytimes.com/2007/02/28/business/28mortgage.html The easy money is making a quick exit out of risky mortgages. During the housing boom that ended in 2005, money was poured with abandon into exotic home loans that let people buy homes with little down or without verifying their incomes. Now, lenders, financiers and buyers of mortgages are pulling back. In a sign of that wariness, Freddie Mac, one of the largest buyers of mortgages, said yesterday that it would tighten lending standards and stop buying certain kinds of risky home loans made to borrowers with weak, or subprime, credit records. The move comes as default rates are rising, smaller lenders are starting to fail and investors are shunning bonds backed by mortgages. The pullback will be most severely felt by minority and poor home buyers and owners, who will face trouble in refinancing adjustable rate loans that they can no longer afford. Those looking to buy homes with a small down payment or none could also be forced to pay higher interest rates and may not be able simply to declare their income without providing documentation like tax returns and paycheck stubs. âLenders and originators are being significantly penalized for the loose standards that we saw last year,â said Brian J. Carlin, head of fixed-income trading at JPMorgan Private Bank. âAnd they are going to take that out on current borrowers.â Financiers and buyers of mortgages are more concerned about the risks of their own investments. Though some skeptics and critics had been concerned about subprime mortgages for several years, the mortgages only recently began falling out of favor on Wall Street. The tipping points have been weakness in home prices and rising default rates among mortgages written as recently as the first half of 2006. In certain kinds of loans, the default rates six months after mortgages were issued are two or three times higher than defaults at the same stage among loans written in 2005. Indeed, concerns about the deterioration of the subprime market have weighed on financial stocks. Those concerns persisted yesterday amid a sharp sell-off in stock markets around the world. Although large forces in the mortgage market, Freddie Mac and its larger sister, Fannie Mae â both created by Congress â have played a small and diminishing role in the subprime business as large Wall Street institutions and hedge funds have become more active. The mortgage agencies do not buy such loans directly from the companies that write them, as they do with prime loans. Instead, Fannie Mae and Freddie Mac buy bonds backed by subprime loans. Even as the market was growing in recent years, the agencies were pulling back; they bought $119.8 billion of subprime bonds in 2006, down from $169.4 billion in 2005 and $175.6 billion in 2004, according to Inside Mortgage Finance, a trade publication. But Freddieâs announcement is confirmation to other investors in mortgages that a segment of the market that was once Wall Streetâs darling finds itself in the doghouse. âFreddie is giving its stamp of approval to what the market has already done,â said Dwight Jaffee, a real estate finance professor at the University of California, Berkeley. âAlready consumers were going to be finding these loans harder to get.â In another sign of problems in the sector, the Corporation">Fremont General Corporation, a large provider of subprime mortgages through brokers and lenders, postponed filing earnings for the fourth quarter and for 2006. Yesterdayâs move by Freddie Mac comes at a time when the Democratic-controlled Congress is taking up bills to restrict what critics call âpredatory lendingâ and measures intended to limit Freddie Mac and Fannie Mae, which have been under scrutiny in recent years because of accounting problems. The agencies were created to make it cheaper for Americans to buy homes, by buying mortgages and packaging them into tradable bonds; together, they buy one in five home mortgages issued nationally. Freddieâs move was praised by Democratic leaders in Congress and housing advocacy groups. The groups have criticized lenders, saying they take advantage of unsophisticated home buyers by giving them loans that are more costly and onerous than they could qualify for. But the Mortgage Bankers Association of America questioned the decision, saying it would hurt minority and other underserved home buyers. In a statement released yesterday, Fannie Mae said subprime loans represented just 2.2 percent of its business and it would not change its approach to the market until its regulator, the Office of Federal Housing Enterprise Oversight, hands down guidance on mortgages. Richard F. Syron, Freddieâs chairman and chief executive, noted that the agencies played a small part in the subprime market, with his agency holding about $184 billion of subprime securities in its portfolio. Still, he added, Freddie Mac and Fannie Mae would be called upon to play a bigger role as more lenders and investors pull out of the market in the coming months. He also rebutted the idea that the agencyâs move would hurt borrowers. âYou have to come back to the question: Do you want someone that is in a difficult situation now to get themselves into an even more difficult situation later on because they have postponed a day of reckoning?â Mr. Syron said in a telephone interview yesterday. Freddie will put its new, stricter standards into effect for loans written on Sept. 1 and after. The impact will be greatest on adjustable rate mortgages that have a low fixed rate for the first two or three years but that adjust to higher rates after that. Under the new guidelines, borrowers will have to qualify as if the higher rates were already in effect. It will also âstrongly recommendâ that lenders collect borrowersâ taxes and insurance payments and put them in escrow for borrowers, a common practice in prime lending but one that is not uniformly followed in the subprime world. But the Mortgage Bankers Association criticized the move, specifically Freddieâs decision not to buy bonds backed by adjustable rate mortgages if borrowers do not make enough money to make payments at the highest possible rate under the loans. Lenders will often make such loans based on borrowersâ ability to pay the low initial payments. Kurt P. Pfotenhauer, a senior vice president with the mortgage bankersâ group, said most borrowers refinance their loans before they adjust to higher, variable rates. He also noted that though defaults were rising, only 13.5 percent of subprime borrowers were either behind on payments or in foreclosure. âPut another way, 86.5 percent of people who have subprime ARMs are paying on time,â he said. The Federal Reserve reported yesterday that 2.11 percent of residential loans held by banks were delinquent at the end of 2006, the highest that figure has been since 2002. Still, other industry officials say the debate over Freddieâs new, tighter standards will most likely be moot by the time they take effect, because bankers and brokers are already well on their way to tightening the money flowing into the housing market. First Franklin, one of the nationâs largest subprime lenders and a subsidiary of Merrill Lynch & Company, recently told mortgage brokers it does business with that it was raising the minimum credit scores for borrowers who wanted to finance 100 percent of a homeâs purchase price. All first-time home buyers will be required to put down at least 5 percent of the purchase price, or verify their income with tax documents. Community HousingWorks, a counseling service in San Diego, has seen an influx of borrowers who are in default on adjustable rate loans that had a fixed interest rate for the first two years of the loanâs life. Gabriel del Rio, homeownership director at the counseling service, said many of the people are stuck in a tough place because weak credit scores make it hard for them to get another loan and the falling value of homes in the area has made it harder to sell properties bought in recent years. The price of single-family homes fell 4.5 percent in San Diego in the fourth quarter, according to the National Association of Realtors. âWe are getting about one call a day, and that started in the last quarter of last year,â Mr. del Rio said. âBefore then it was literally nothing. We got one or two calls a year.â Robert Moulton, who owns a mortgage brokerage firm on Long Island, said the industryâs greatest failing was not fully anticipating or preparing for the troubles of the housing market, especially the drop in home prices in some areas. Too many people believed that home prices would not or could not fall. Adjustable rate loans made sense as long as home prices were rising; borrowers could sell their properties for more than they bought them or refinance using their rising equity. âWhen these subprime loans were written, I honestly donât think anyone from the borrowers to the bank anticipated a collapse in real estate values,â he said.