The REIT Stuff, Austerity Relief and DOJ

 | Apr 19, 2013 | 6:06 PM EDT
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As the past week's trading raised concerns regarding a pause, Washington's mixed cocktail of policy risk and opportunity could once again noticeably add to, or help relieve, investors' dyspepsia. Here is a freshened-up trio of D.C. stories.

Are mREITs (Still) Just All Right With Me?

The Wall Street Journal reports this morning that the Financial Services Oversight Council (FSOC) will discuss at its meeting next week new concerns that leveraged mortgage REITs, or mREITs, could be dangerously exposed in the event of interest-rate spikes or as the result of their reliance on short-term funding agreements.

The story adds another potential layer of risks for large mREITs like Annaly  (NLY) and American Capital Agency (AGNC), which investors began fretting about from a policy perspective after SEC staff issued a fall 2011 concept memo.

As I wrote at the time, that document asked whether changes in the industry and issues raised by the financial crash might warrant a fresh review of the mREITs' decades-old exemption from registration under the 1940 Securities and Exchange Act.

The threat now might be that the companies could be required to hold more capital and suffer other constraints if the FSOC's "shadow economy" concerns lead it to designate $100 billion-asset firms like Annaly and American Capital Agency as "systemically important financial institutions.

These and other mREITs have played an important role in sustaining mortgage liquidity as Fannie Mae and Freddie Mac have been forced to shrink their portfolios.

Meanwhile, it's also not clear whether the FSOC's focus might belie earlier expectations that the SEC '40 Act review was likely to prompt release this spring of a new and largely non-threatening "interpretive guidance" for companies exploiting the exemption, blessed by SEC staff and/or the commissioners.

Any major threats to the high-yielding mREITs could dilute what has been a terrific area of diversification for investors over the past several years, dumbed down for the masses in exchange traded funds like Market Vectors Mortgage REIT ETF (MORT), whose 15% return since its August 2011 launch has been roughly half that of the Dow and S&P 500. 

How Do You Spell Near-Term Austerity Relief?

S-I-M-P-S-O-N -- B-O-W-L-E-S (II)

Separately, on the constructive side, Simpson and Bowles have just proposed an updated version of the earlier "Moment of Truth" deficit reduction proposal they issued as presidentially-appointed heads of the National Commission on Fiscal Responsibility and Reform in December 2010. 

The two begin by crediting Congress and the White House for already having reduced deficits by $2.7 trillion, largely via the 2011 Budget Control Act and January 3 fiscal cliff fix, the American Taxpayer Relief Act. 

They then propose at least $2.5 trillion more, to be achieved through a 2-1 mixture of spending cuts and revenue hikes -- the latter to be guaranteed via a "fail-safe" mechanism imposing an across-the-board limitation of tax expenditures if Congress fails to enact specific reforms  via a zero sum review of all personal exemptions and deductions.

It's worth noting that Congress could pass one-half to two thirds of their updated solution and still declare victory based on the $4 trillion deficit reduction goal they first laid down in December 2010.  

More importantly, this could allow restoration of 70% of the first year's defense and non-defense discretionary spending cuts (and a similar percentage over a decade) that are being forced by the ongoing and much maligned sequester. 

In other words, Congress could reduce austerity-related pressures through the end of 2013 or into 2014 -- albeit with tradeoffs in any "mini-grand bargain", as in phased-in movement toward Diet COLAs (or reduced cost of living adjustments for Social Security beneficiaries and stingier inflation-indexing of federal tax brackets) as well as yet another gradual tax hit for investors and upper income wage earners.

The net effect might be little better than a wash after the first year, although I'd bet that just removing the U.S. austerity imperative might produce another global investment signal that, on a relative basis, 'America is where it's at.'

And How About Unlocking Less Defensive Mortgage Lending?

Finally, on the housing front, look for two potential catalysts. Realizing that its alpha bit soup of relief programs for underwater middle class borrowers has reached diminishing returns, the administration will try to juice the last mile of the already-crested refi wave via one more concentrated marketing campaign to target 750,000 to 1 million GSE-backed borrowers who have failed to take advantage of record low interest rates under the federal HARP program. 

Administration sources think they can refi another half million as a result; I join mortgage industry sources in being skeptical. But any boost would reduce the overall drop off in net mortgage activity presaged by the Wells Fargo (WFC), JPMorgan Chase (JPM), Bank of America (BAC) and Citigroup (C) earnings reports earlier in the week.

Meanwhile, perhaps more promising is word that the administration might try to boost the flow of credit to first time homebuyers by persuading FHA lenders to reduce credit overlays, or additional costs or underwriting constraints, that have either priced out or precluded LMI borrowers from the market. 

Per a source, this might involve the subtle equivalent of "horse whispering" from the DOJ and HUD Inspector General, more than any pledge that the Obama administration is willing to go "soft on crime." 

Specifically, with virtually every major large lender having been subpoenaed for potential FHA- or GSE-related false claims charges to be brought by the government, merely updating those investigations to narrow down which firms are truly being targeted, and for what, might have a huge unlocking effect.  

I repeat: Housing is in recovery, mortgage lending is in decline. But the slope and timing of that decline -- plus removal of at least one barrier to household formation -- could be big for everybody from the banks, servicers -- Ocwen Financial (OCN), Nationstar Mortgage Holdings (NSM) -- appraisers, title companies and private mortgage insurers -- Genworth Financial (GNW), Radian Group (RDN), MGIC Investment (MTG) to the second half of 2013 economy writ large.

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