NUTS & BOLTS
DODD FRANK
hanges to Dodd-Frank have already been proposed by the Trump administration. New Treasury Secretary Steven Mnuchin has made somewhat conflicting statements regarding the privatization of Fannie Mae and Freddie Mac, but he stated in his confirmation hearings that he is unequivocally committed to housing reform to include government-sponsored enterprises (GSEs). Fannie and Freddie’s strong earnings in 2016 may win them a short-term reprieve, but reform is on the horizon. What do these big potential changes in the banking and mortgage sectors mean for market liquidity and access to capital for borrowers and lenders? First, a little background. RUN-UP TO DODD-FRANK The Dodd-Frank Act was passed in reaction to the Great Reces- sion of 2008, but its origins can be traced to the Great Depression. Enacted in 1933, the Glass-Steagall Act first separated investment and commercial banking. At that time, rampant stock speculation within the banking industry was cited as a main contributor to the stock market crash of 1929 and the subsequent Great Depression. While Glass-Steagall was effective in separating consumer deposits from securities investments—and in turn creating an era of stabil- ity—it was also criticized for limiting competition and fostering an inefficient banking industry. Cracks in the Glass-Steagall armor first appeared in the early 1960s, when regulators began permitting banks to engage in cer- tain securities-related activities. Congress repealed Glass-Steagall in 1999, but by that time the Act effectively had been circumvent- ed by Federal Reserve Board actions, including allowing Citibank to affiliate with broker Salomon Smith Barney. The resulting mergers created megabanks with split personalities—conservative commercial bankers working alongside risk-loving investment bankers. The latter group won out, creating an economic boom fueled in part by the housing industry. Banks issued residential mortgages using lax underwriting standards, then securitized the mortgages into mortgage-backed securities (MBS) that were What Change Lies Ahead? HOW MIGHT REVISIONS TO DODD- FRANK AND THE GSES AFFECT THE LENDING ENVIRONMENT? by Robert “Bobby” Montagne C
ments to rein in underwriting standards, removed some financial incentives for mortgage originators to ignore a borrower’s ability to repay, and strengthened loan disclosure procedures, among other mortgage reforms
snapped up by investors. The rating agencies didn’t help, as they assigned high ratings to these securities that later turned out to be less than investment grade (i.e., “junk”). As everyone recalls, it all ended badly. The mortgage melt- down of 2007 witnessed the loss of hundreds of billions of dollars in value tied to securities and real estate, followed by government bailouts of banks that were deemed “too big to fail.” Many blamed the crisis, at least partially, on the repeal of Glass-Steagall, while others claimed the meltdown would have occurred even if Glass-Steagall had still been in place. DODD-FRANK ENACTED IN 2010 The “Wall Street bailout” was unpopular with many Ameri- cans, and various pundits attributed the rise of the Tea Party to such intervention. After years of debating the issue, Congress passed Dodd-Frank in 2010. It was a sprawling bill that, while not completely restoring Glass-Steagall, did succeed in changing the nation’s financial landscape. Among its provisions were: The Volcker Rule: Aimed at reducing speculation, the Volcker Rule banned depository banks from virtually all proprietary trading in hedge funds and private equity funds, and prohibited conflict-of-interest trading Financial oversight: Created two new agencies to moni- tor and regulate the health of the economy and mandated that banks create “living wills” governing their procedures for handling financial distress Orderly liquidation: Created rules to place failing finan- cial institutions into receivership and started an industry fund to help pay for liquidations Proxy access: Gave shareholders expanded rights to nominate corporate directors Registration: Required managers of hedge funds and oth- er private equity entities to register with the Securities and Exchange Commission Insurance regulation: Created new regulations governing the insurance industry Swaps: Created a transparent mechanism for trading swaps Protection: Introduced a variety of new protections for investors and consumers, including the establishment of the Consumer Financial Protection Bureau (CFPB) Mortgage reform: Instituted “qualified mortgage” require-
and operated that way until 2008. In September 2008, the U.S. Treasury Department bailed out and took over Fannie and Freddie in order to guarantee their losses and reassure the financial markets that the banking system was solid. Since 2012, Fannie and Freddie have been required to send all their profits to the Treasury. Some investors have sued the government for those profits, and many have pushed to allow them to rebuild their capital and be released back to the private sector (recap-and-release). During his confirmation hearing, Secretary Mnuchin was vague on his exact feelings about privatization and recap-and-release with regard to the GSEs, yet stated that housing reformwould be one of his priorities. Fannie and Freddie posted strong earnings for 2016, which could help them escape intense scrutiny in the early months of the admin- istration, but recap-and-release and other GSE reform discussions are unlikely to go away completely. The GSEs remain the single most important source of liquidity in the mortgage market, and their strong performance is also a good indicator of market stability, a positive sign for borrowers for the year ahead. Dodd-Frank is so ingrained in the fabric of the big-bank system, it would be cumbersome, expensive and difficult to implement a blanket removal of the new regulatory landscape. Big banks have embedded the Dodd-Frank regulations into their operating systems and will be slow to change back (if ever) even if permitted. Besides, traditional banks still remember the Great Recession and have gone to great lengths to install alleged “safeguards” in their systems. You can’t unsalt French fries; private lending is here to stay. Further, the potential recapitalization of Fannie Mae and Freddie Mac and the resulting positive effect on liquidity in the residential mortgage industry should stimulate sales of rehab and fix-and-flip properties. If, as the Trump administration has promised, the econ- omy continues to grow, there will be continued demand for liquidity from banks and private lenders alike. And if gross domestic product accelerates across the board, real estate borrowers will require fast and flexible capital, the likes of which traditional banks may not be capable of fulfilling—regardless of Dodd-Frank’s status. • Bobby Montagne is a real estate entrepreneur with three decades of experience in commercial and residential property development, finance and sales. After developingmore than 1,200 residential units and 200,000 square feet of commercial space in theWashington, D.C., metro area, Montagne started flipping houses on a large scale. He renovated and soldmore than 200 row houses in D.C. neighborhoods such as Petworth and Eckington. After seeing firsthand the potential of the fix-and-flip market inWashington, D.C., and realizing that lack of capital was holding back many real estate investors, he foundedWalnut Street Finance, a private money lender, in 2016. He now funds renovation projects in the District of Columbia, Virginia, Maryland and Delaware. WHAT THIS MEANS TO REAL ESTATE INVESTORS
THE TRUMP ADMINISTRATION’S EXECUTIVE ORDER
As Will McDermott, editor of Scotsman Guide Residential Edi- tion, points out in a recent article, President Trump and the Repub- lican-controlled Congress are advocating for repeal of Dodd-Frank and the neutering of the CFPB. On Feb. 3, 2017, President Trump signed an executive order to begin rolling back Dodd-Frank. While receiving a lot of press, the order really only set in motion a three-month review process, to be conducted by the Treasury secretary, to find areas where the law can be changed. The president’s executive order contained seven “core principles”: 1 Empower Americans to make independent financial decisions 2 Prevent taxpayer bailouts of financial institutions 3 Conduct impact analysis of regulations 4 Make American companies more competitive abroad 5 Fight for American interests against foreign regulations 6 Streamline the regulatory process 7 Restore public accountability within federal agencies On the face of it, few lawmakers would argue with these general principles. But, as they say, the devil is in the details. It remains to be seen what exactly those details entail. Flat-out repeal of Dodd-Frank would require 60 votes in the Senate, which seems like a tall order, but the Washington landscape changes very quickly. Other changes, such as restructuring the com- position of the CFPB, can be made with a simple Senate majority. The political problem for the president is that he campaigned as a populist who condemned the Wall Street “fat cats.” It would be hard to reconcile that position with repealing consumer-friendly Dodd- Frank, but President Trump may be able to muster enough support to succeed, despite any conflicts in logic. GSES AND RECAP-AND-RELEASE Mortgage GSEs were first created in the 1930s to raise home ownership and affordable housing rates in response to the housing crisis of the Great Depression. They purchase mortgages that are sold by lenders on the secondary mortgage markets and currently hold more than $5 trillion worth of mortgages. The most famous of these GSEs, Fannie Mae and Freddie Mac, were originally set up as privately owned corporations chartered by the federal government
82 | think realty magazine may :: june 2017
thinkrealty . com | 83
Made with FlippingBook - Online Brochure Maker