Since the start of the coronavirus crisis, the Federal Reserve has won admiration from many quarters for the pace and magnitude of its interventions to stabilize financial markets. Certainly, the Fed has taken crucial steps to resuscitate the liquidity facilities created back in 2008 — as well as developing some new ones. On April 28 it even expanded the Municipal Liquidity Facility, agreeing to purchase large volumes of short-term debt issued by small counties and cities in the United States. Equally striking has been the Fed’s decision to purchase corporate junk bonds.
But little attention has been paid to one very peculiar aspect of the Fed’s actions — namely its relative lack of intervention in the private-label mortgage-backed bonds that come without (either implicit or explicit) US government guarantees. After much panhandling by commercial real estate lobby groups, the Fed has only agreed to purchase the top-rated such bonds issued prior to the crisis. Privately issued residential mortgage-backed securities have been left out of the Fed purchase programs designed to inject liquidity in capital markets.
Moreover, unlike in the wake of the 2008 housing crash, no direct help has been announced in the form of purchasing bonds issued by cash-strapped mortgage providers and servicers. The Fed has done the bare minimum with regard to real estate — despite clear signals of a serious downturn in real estate, which will devastate homeowners as well as small and medium businesses. Not only the Fed but also the Trump administration appears unwilling to act with direct and sufficient stabilizing force to halt the storm that’s brewing.
The explanation probably lies with political developments in the aftermath of the Great Recession of 2007–9, which first erupted in the real estate market. Bankers were bailed out, but homeowners were left to sink. The rescue of bankers was followed by over a decade of anemic growth, creating political circumstances which now greatly limit the authorities’ discretion with regard to real estate. More precisely, the Fed knows that, if it bails out the real estate sector, it will stoke mass ire and further jeopardize its “independence” at a time of rising scrutiny and calls for democratic accountability from the Left.
Yet an even more immediate threat for the Fed comes in the form of the rancid reactionary populism of Donald Trump — ever ready to deflect popular anger by shifting the blame for economic problems onto the central bank. The result is that the Fed seeks to be acting in lockstep with Congress and the president to avoid the blame for yet another bailout of the real estate sector. The longer it waits, however, the worse the downturn will be and the greater the eventual popular uproar.
Similar constraints are also affecting the US government. Both the Republicans and the Democrats know that whoever pushes first for a massive bailout package for the real estate sector will be charged with implementing a deeply unpopular policy. In turn, this will provide the opportunity to the other side of the aisle in Congress to fulminate and masquerade as the outraged tribune of the people.
The underlying tensions led to a situation of inertia, with Congress largely adopting a “wait and see” position. Meanwhile, the Fed continued to encourage Congress to pass more fiscal stimulus while deceptively claiming it had done everything it could do on its own. The only politically viable option for temporarily propping up real estate was through a bill comprised of direct income transfers to homeowners and renters as well as more direct bailout measures. This has now come in the form of the $3 trillion Health and Economic Recovery Omnibus Emergency Solutions (HEROES) Act introduced by the House Democrats under Nancy Pelosi, which amalgamates several individual pieces of legislation.
Buried among the many provisions there is $75 billion in mortgage relief and $100 billion in rental relief for low-income earners, as well as the ability for all borrowers to claim forbearance for up to a year. The bill also would allow the Fed to lend to mortgage servicing companies and directs it to set up a new emergency lending facility to owners of rental residential properties. The bill also comprises tax cuts primarily benefiting the rich, bailouts for corporate lobbyists and dark money in politics, as well as subsidies for health insurance companies (and not an expansion of Medicare or Medicaid). At its best this bill is little more than a blackmail of the working class into accepting political measures that further tilt the balance of power in favor of the wealthy. While the bill will pass the Democrat-controlled House, its catchall nature will see it rejected in the Republican-controlled Senate for the foreseeable future. The political decrepitude of US capitalism is manifest — while the situation in real estate worsens with each week.
The Shock to the Real Estate Market
At its core, any property’s price is capitalized annual rent. Rents will fall if unemployed workers cannot make the payments on their homes, or if commercial businesses go delinquent due to a lack of trade. The actual and expected fall in rents thereby leads to a decline in property values. Similarly, the value of mortgages held on a lender’s book as well as the prices of residential mortgage-backed securities (RMBS) would decline if future payments were expected to be interrupted or disturbed. This also means that RMBS would become less acceptable as collateral in other loan transactions, thus further fueling liquidity problems across the financial system.
There is little doubt that enormous pressures on rents and returns have already accumulated in the US real estate market as a result of the coronavirus crisis. The loss of thirty-three million jobs and an unemployment rate that is expected to reach 20 percent has led to forecasts of falling apartment rents and rising vacancies. Also crucially important is the Coronavirus Aid, Relief, and Economic Security (CARES) Act, passed into law at the end of March. It aims to support families by basing the declaration of mortgage payment forbearance “on the honor system.” In other words, the law makes it easier for borrowers of home loans to postpone mortgage payments without necessarily providing evidence of financial distress and/or lack of employment. Given the bleak prospects of recovery and employment, it is entirely understandable that many people are likely to opt in to this system, even if they have not yet been laid off. It is no surprise, therefore, that by the end of April 7.3 percent of all mortgages were in forbearance.
In all, the residential mortgage market, which totals over $11 trillion, has become increasingly distressed since the start of the crisis. In the commercial real estate market, meanwhile, commercial mortgage-backed securities (CMBS) delinquencies are expected to rise to Great Recession levels. Already from March to April, payments on CMBS loans from retail properties and hotels to reach over thirty days late have ballooned by over 10 and 20 percent, respectively. CMBS that are backed by multifamily residences are also expected to suffer as struggling families forego rent. Thomas Barrack — the most outspoken voice for commercial real estate — has declared that the sector is close to total collapse given the lack of rent payments and the sheer volume of forbearance requests. Although such a figure could be expected to exaggerate the severity of the situation, this time it doesn’t seem like hyperbole.
The Fed’s Feeble Response
The panic which ensued from the coronavirus stock market crash after March 20 and the expected repercussions on the real estate sector led to massive losses in mortgage-backed security trading. These losses were also apparent in the stock values of real estate investment trusts (REIT), companies specializing in owning and operating real estate. The price indices of the real estate sector seemed to be in free fall.
In response, the Federal Reserve ramped up its purchases of mortgage-backed securities issued by Fannie Mae and Freddie Mac (the two major government-sponsored enterprises which provide mortgages) as well as those guaranteed by Ginnie Mae (which is wholly government-owned). The Federal Reserve, however, refused to purchase any other types of mortgage-backed securities issued by private financial institutions, such as banks.
After much lobbying by the commercial real estate sector, on April 9 the Fed finally began to purchase private AAA-rated CMBS debt issued before the coronavirus shock. However, until now it has announced no plans to purchase new privately issued CMBS debt. This means that the big banks, which typically offer such private CMBS debt, will greatly contract their issuance this year, fearing that there will be no buyers. Thus, the real estate sector faces the prospects of a freeze in the private CMBS market, which is worth $500 billion, with large amounts of that debt going delinquent as businesses shut down across the economy.
Commercial real estate debt as a whole amounts to a massive $3.6 trillion. Much of this debt is tied up in even more illiquid and opaque loans than the CMBS, which are publicly traded. Things look even worse in the residential mortgage-backed securities (RMBS) market. At present the Fed continues to buy only RMBS from Fannie Mae and Freddie Mac or RMBS guaranteed by Ginnie Mae. No purchases of privately issued RMBS seem to be forthcoming from the Fed even as it has announced its decision to purchase corporate junk bonds.
Furthermore, the Fed has not yet announced any plans to purchase bonds issued by loan servicing companies which are backed by loans made to mortgage borrowers who have missed their payments. Given the extraordinary rate of unemployment, it seems strange that the Fed has been slow to replay this aspect of its book from 2008–9, when it did purchase such bonds to ease the burden on loan service companies. The liquidity pressures and danger of collapse in the market in 2020 have naturally escalated.
The Parlous State of Mortgage Service Companies
But there is even worse to come. Both the private commercial banks and the government-sponsored enterprises (GSEs — i.e., the mortgage giants Fannie Mae and Freddie Mac) use loan servicers for the mortgages they hold. The loan servicers are legally liable for advancing the monthly sum of mortgage payments before collecting these from the borrower. As forbearance rates have risen dramatically the loan servicing companies have become terribly squeezed since they are forced to advance monthly payments on behalf of borrowers.
The Federal Housing Finance Agency (FHFA), which regulates the two GSEs, announced that loan servicers would only need to advance four months of loan payments to Fannie Mae and Freddie Mac. For its part, Ginnie Mae, which is directly owned by the federal government, has decided to lend to loan servicers. Furthermore, the FHFA announced that Fannie Mae and Freddie Mac will begin purchasing mortgage loans that went into forbearance within a month’s time after closing between February and May. Any such purchases will be at a 5 to 7 percent discount of the value of the loan, thereby hurting lenders. Fannie Mae and Freddie Mac do not themselves have the funds to last for much longer than two months due to a total lack of mortgage payments.
Unfortunately, this is just the tip of the iceberg when it comes to distressed home mortgage loan originators and servicers. Many loan servicing companies are actually local independent mortgage banks that function as non-depository institutions that issue mortgages to single-family homes before selling these loans to bigger banks, Fannie Mae, Freddie Mac, or to other institutions (Federal Housing Administration, Veterans Affairs, etc.).
The local mortgage banks filled the vacuum left by the decline of mortgage lending by banks in the aftermath of the 2007—9 crisis. They are now responsible for over 50 percent of all single-family home mortgages in the United States. These local independent mortgage providers form the capillaries of the US residential real estate system. They can be pictured as streams that combine under larger aggregating institutions, such as commercial banks, government-sponsored enterprises, and other federal home loan programs that fund homeownership in the United States through the issuing of mortgage-backed bonds.
Independent mortgage banks now also originate over 80 percent of all Federal Housing Administration loans, which cater specifically to lower-income borrowers, and 64 percent of mortgages to minority households. The role of the Federal Housing Administration in providing home loans to poorer working-class borrowers has increased in the wake of the 2008 subprime crash, and it decisively depends on independent mortgage banks to originate and service loans where all the paperwork tied to a mortgage is also held.
Thus, the current disarray of independent mortgage banks due to the requirement of advancing mortgage payments to GSEs or bondholders as forbearances skyrocket portends disaster — not just for the residential mortgage market, but for real estate finance as a whole.
The Prospect of a Generalized Crash
There is a real prospect of another housing crisis in the coming period as housing prices fall — leaving mortgage borrowers underwater. Loan servicers and local mortgage banks would probably shut down and their assets would be taken over by the bigger banks, which became notorious for unfairly foreclosing mortgages in the aftermath of the last housing bubble.
Aside from the pressure that has already accumulated in the form of delayed rent payments and forbearance, it is quite likely that low-income households that are still in employment and are not allowed to request forbearance would suffer from a cutback in their hours of employment. The result would be a further spiral of mortgage failures bringing more families on the brink of losing their homes. Some form of a mortgage crisis disproportionately affecting minorities is likely to happen even if the lockdown comes to an end throughout the country by June.
The ferocity of the downturn in the real estate sector will become clear once attempts are made to resume business as usual after the lockdown. Heavy turbulence in the RMBS market, which is worth over $10.3 trillion, would ripple across capital markets and the banking system. RMBS that are not guaranteed by Freddie Mac, Fannie Mae, or Ginnie Mae total over $1.7 trillion and would probably be the eye of the storm.
Why Such a Lack of Intervention?
The question naturally arises: Why have the Federal Reserve and the government so far failed to preempt such a crisis? The answer, as we have suggested, is deeply political. The Fed is worried about maintaining its long-term independence from Congress and the executive branch of government. Therefore, it has to engage in a balancing act of not doing too little to support the real estate market, while simultaneously avoiding the risk of being accused of going too far without congressional approval. Inevitably, the Fed has sought to move in lockstep with the government on the tricky business of another bailout for the real estate sector.
For the government, on the other hand, the problem is the bitter memories etched into working people from the bailout of bankers after the burst of the subprime mortgage bubble in 2008–9, when homeowners were left to drown first under a Republican and then a Democratic administration. Jerome Powell at the Fed and Steve Mnuchin at the Treasury are fully aware of this, as is also Donald Trump, for whom this is an election year. The stakes could not be any higher — and the real estate sector is political poison.
If some kind of bailout was urgently delivered, the Trump administration could be attacked by the Democrats for propping up the bankers and real estate moguls. And if the Trump administration waited until Democrats in Congress worked with the Republicans on passing legislation, the potential economic fallout from an ever bigger crash could compromise the chances of victory in November. Therefore, the government and the Federal Reserve were caught between a rock and a hard place.
Now with the HEROES Act, the situation has dramatically changed. The Democrats have signaled their willingness to work urgently on stimulus and real estate bailout measures, but only if many other pieces of their legislative agenda are also accepted. The Republicans have already declined this offer but stand to lose as the economic situation worsens day by day, as the Democrats will now look to inculpate them for the unfolding economic disaster. For now, it is uncertain what will come of this game of pin the donkey’s tail.
But three things are clear. First, there will probably be a crash in real estate values in the coming weeks and months, although it is hard to say exactly how severe it will be. Second, barring a miraculous quick passing of the HEROES Act by Senate Republicans, there will also definitely be a mortgage crisis — with the poorest first in the line of fire. Third, the worsening of the mortgage crisis will be followed by some form of a bipartisan bailout for the real estate sector, while funding would also be provided through other liquidity facilities. The Left should immediately start to prepare for the difficult fight ahead to ensure that this time there will also be a bailout for households. This also means using this crisis to start laying the foundations for housing to become decommodified — treating a place to live as a fundamental universal right.