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When Government and Industry Meet

This piece originally appeared in the October 2022 edition of MReport magazine, online now.

In 2020, MReport profiled mortgage industry veteran Frank Pallotta, who was then running for the U.S. House of Representatives for the 5th District of the state of New Jersey. After a strong but unsuccessful showing in that year, Pallotta is now back on the ballot and hoping to flip his district in November’s election. (To read our previous interview with Pallotta, click here).

With a career that took him through several decades of work within the financial services sector, including stints at Goldman Sachs and Credit Suisse, Pallotta once again took some time to speak with MReport amidst the hectic schedule of the campaign trail. He spoke about his priorities and focuses for this election cycle, the challenges facing the American housing market, and what he hopes to accomplish should he emerge successful from this election.

How can the government and the mortgage and housing industries work to help renters and homebuyers surmount the many headwinds facing Americans in search of homeownership or even just affordable rental housing in 2022 and beyond?
Homeownership is something we’ve seen pick up not just over the last 10 years. This is something we’ve seen across the last 50, or 60, or 70 years. It’s helped move a lot of people out of poverty. It’s helped move a lot of people from middle class to different levels. What the government has done in the past, for the most part, has been great.

The GSEs do a tremendous job of helping provide, not just liquidity, but opportunities. We have seen some challenges over the last 20 or 25 years. Clearly, in 2008, we saw some challenges where credit was being stretched, but then we saw interest rates come down. We saw more sound guidelines coming into play.

It was the marriage of both the public and the private sectors, coming together to find out, first and foremost, how to protect taxpayers. The GSEs, as we know, guarantee timely payment of principal and interest, and they do that in a way that ensures they put together a structure and a set of guidelines that protect taxpayers when they offer the opportunity to securitize those loans, and back those loans. As the world evolves, as our economy evolves, first and foremost, we obviously have to protect the shareholders, which means the taxpayers in these instances.

We also have to make sure that, while homeownership is more privileged than anything else, that it’s done in a responsible way. I would guess the vast majority of those who use government-backed programs, whether it’s their VA programs or other HUD-related programs, or Fannie or Freddie programs, that it’s happened in a way that people have used those, not as a crutch, but as an opportunity to do what’s best for them and their families.

I would always like to consider—because I think it’s worked, if it’s done in a sound way—the marriage of the public and private sectors. Not just the ability to provide liquidity into the capital markets by guaranteeing loans through Fannie and Freddie and Ginnie and then having them trade in the capital markets, but by being creative. I think the private sector is creative. The government needs to work with the private sector in a sound way, again, that protects the taxpayers in helping provide more homeownership.

What I mean by that is, if there are ways, as credit standards are changing, and the economic environment is changing, we need to work with people who have both the desire and the wherewithal to own homes. I’m about making sure that the government doesn’t bear the entire burden, but if we soundly open the doors a bit, and work with the private sector, it’s done in a way that helps protect the taxpayers, ultimately.

I know you were in the industry during the previous financial crash and housing crisis in 2008. What are some parallels you see between then and our current economic and housing landscape? What lessons from that period can and should be applied today?
The biggest difference that we’re seeing is that, with the financial crisis in 2008, there were probably seven or eight years that led up to it. It was mostly, in my mind, caused by irresponsible lending practices. We saw a lot of questionable documentation programs.

When you marry questionable documentation with hundred LTV loans, there’s not a lot of room for error. We know that the primary cause for the decline that we saw is not just the increase in default rates but also the increase in foreclosure rates at 100% LTV loans, where we know they get executed, or at least liquidated, at points that are below market value. What we’re not seeing now is a lot of irresponsible, high-LTV lending. I’m glad that’s the case.

What I do also like that we’re seeing is, we’ve got a lot more folks in government lending, or government-related—the Fannies and Freddies of the world—that are very conscious of true risk management. I think there was a concentration for a long time on providing homeownership with a secondary, or even tertiary, look at what the real risk was. Now, I’m glad that there’s a great deal of focus on protecting the taxpayers.

We have seen a precipitous rise in home prices. I get comfort when that rise, when increases in home prices, is organic—when it’s people moving for reasons that are fundamentally sound in the long term. What we have seen over the last three-and-a-half years is a combination of a fundamental pickup in home prices, which have to do with supply and demand, but also a lot of the movement that we’ve seen outside of cities into the suburbs, which is COVID-19 related. That’s clearly a short-term technical move, and we are starting to see some home prices come off the top. A lot that has to do, in part, with coming out of the COVID-19 crisis.

It’s also about the increases we’ve seen in mortgage rates. As you take a look at what’s gone on over the last maybe 18 months or so with inflation statistics, and deficit numbers, you are seeing a pickup in inflation. There’s going to be some difficulties around.

There aren’t a lot of ARMs, but the ARMs that we have out there, will begin to reset. They’ll begin to reset at much higher rates. People will generally solve for what they can afford, in terms of a monthly payment, not necessarily about the home they can afford, the payment they can afford. There’s going to be an adjustment of solving for what you can afford.

I get a comfort level when I understand that there are people both in the public and the private sectors who are keeping an eye on what happened a decade ago. It’s not like it happened a generation ago; there are firms out there still licking their wounds. I’m encouraged that when you start to see spreads widen, when you start to see interest rates going up, that there’s a general feeling that you don’t open up the credit box to fill in the supply we’re losing because of organic, fundamental changes in the marketplace.

You’ve spoken in the past about why a commitment to not just homeownership, but responsible homeownership is critical to avoiding repeats of past mistakes. Could you expand on that?
One of the programs I helped create after I left Wall Street was something called the Responsible Homeowner Reward Program. As I said earlier, homeownership isn’t necessarily a right; it’s a privilege. There are a number of things that come along with that—the ability, obviously, to make the timely payments of principal and interest. If you can’t, that just doesn’t affect the homeowner, or the guarantor of the loan—it also affects the neighborhood. If there are too many defaults, it affects widespread swaths of our country, which we saw for the first time in 2008. Prior to 2008, there were some pockets of high-default rates and subsequent negative-equity situations. We saw it in pockets of the country where they would close, say, an Air Force base or other military facilities, or a large company moved out of state, and people suddenly don’t have jobs. But starting in 2007 through 2010 is where we saw it on a widespread basis.

Responsible homeownership is important. That’s where I think the marriage of the public and private sectors, not in developing programs to make sure everybody gets a home, but in developing programs and opportunities so that people who do have the wherewithal, in a challenging environment, are allowed to do that, are permitted to do so. If it means some government assistance, as long as the taxpayer is protected, I’m okay with government assistance. If it’s private sector lending, or an increase in private sector lending. We have to keep in mind that a lot of these banks that shared in irresponsible lending practices, a lot of these banks now get their funding from the Fed. When you can borrow from the Fed window, and you have that luxury, you also have a responsibility.

We’ve got different risk management protocols out there to

make sure that we’re doing it. The one thing that we really have to keep an eye on, especially in this environment: even though we are seeing unemployment coming down again, it’s not far down as much as we saw in the recent past, a couple of years ago.

We’re also seeing some challenged pockets in the country, like in my state of New Jersey, where large companies are leaving the state.

We have to have an eye on not just what the borrower can afford today, but what industry that borrower is in, what company that borrower belongs to, whether that company may be looking, longer term, at moving out of a state.

Risk management doesn’t necessarily involve just a static opportunity of looking where the borrower sits today, but a longer-term view of our national economic scene, and then some state and local observations about where companies are moving. I’m all about making sure that people who want to have the opportunity to put a roof over their head can do it, but ultimately, I think taxpayers have to be protected in the private sector, from private sector lenders, and taxpayers have to be protected when the GSEs are involved in lending also.

What does that standpoint look like from an affordable housing standpoint, when rents are also increasing, and many are struggling even to make those ends meet?
We’ve seen a lot of financial institutions that are taking a deep dive into owning and buying properties. I think some of the largest owners of housing over the course of the last decade have been Wall Street firms like BlackRock and others. Again, when financial institutions have the luxury of borrowing from the Fed, they also have the responsibility of making sure that taxpayers are not just protected, but people who are renters are also protected.

It’s a slippery slope when you talk about price gouging, because all things being equal, rents—and home prices to some degree—are a function of supply and demand. But I do think there is a responsibility to make sure that those who want to purchase a home, or want to rent a home, are able to do so.

What we have now is, a lot of financial institutions are becoming landlords. I work with a number of folks who have left Wall Street and are now involved in working with funds that are buying up homes. This situation that we had previously, where we saw widespread defaults, it wasn’t just homeowner defaults, but there were people who couldn’t make their rental payments either. I think a lot of these risk managers who have moved more into property management understand that. They work a lot closer with some of the renters, not just on the front end of making sure that they have the wherewithal to make the rental payments and looking deeper at references. They look deeper at the organizations, and documentation, but in those times where you may see some economic difficulties pop up here or there.

A lot of these risk managers are very focused on protecting and preserving their assets. What that might mean is, if there exists a situation where somebody may not be able to make their rental payment because they lost a job, or they took a job that pays them a lot less, it’s better to figure out how to keep the rent roll going, how to keep the asset cash flowing positive, than it is to say, “You can’t pay, you’re out.” There’s a plus and a minus of having more financial institutions more involved in both the purchase market and the rental market. I just think they need to understand that the government needs to take a more active risk management role, in ensuring that both taxpayers and their residents are protected. Should we get to Congress, that’s something I do want to make sure of: that we’re walking comfortably that line between providing homeowners who understand that homeownership is a privilege, renting is also a privilege, and keeping the taxpayers’ best interests in mind.

If you win the election, what are your priorities in this area of housing, and building off your industry background?
Well, homeownership is a privilege, not a right, but also, I’ve been in the industry long enough to know that look on someone’s face, that look in their eyes when they close on their home, when they close on their first home, and they first move in.

There’s nothing like homeownership. Most of the long-term wealth in this country has been real estate ownership. I think there’s an opportunity, if I get into Congress, to make sure that we’re always thinking outside the box but also keeping an eye on risk management.

Here, in the state of New Jersey, this is the third year in a row that we are the number-one exited state. The reason we’re the number-one exited state is our ridiculously high property taxes. We’re one of the highest in the nation. We have one of the lowest business environments. As a result of having both high property taxes and a terrible business environment, people are leaving the state.

When people leave the state, they’re generally leaving because they want to go someplace where their tax burden is less, but they’re also leaving because corporations are leaving. When corporations leave, they don’t just take the company; they take people with them. In New Jersey, particularly in District Five where I’m running, that’s one of the worst districts, not just in New Jersey, but in the country, for being at risk for negative equity.

We all know negative equity is one of the leading causes, not necessarily of default, but of risk of loss from those defaults. Leadership in this state, from Trenton to a lot of the leaders that we see at the congressional level here in New Jersey, is not providing corporations with opportunities, either through tax breaks, tax advantages, or other things to bring companies back or cause companies who may want to leave, to stay. It’s not just the company that stays. People who are living in their homes, and renting around that corporation, or around that company, they also stay.

I know another priority that you’ve worked with in the past has been working to combat veteran homelessness. What would you plan to pursue on that front, should you win?
Absolutely. Fortunately, in my district, veteran homelessness is not a large problem. A lot of the veteran organizations have had a lot of outreach. They’ve had a lot of reach out to the private sector, and to individuals, to help provide funding and other opportunities for veterans. It certainly is an issue across the state. It’s an issue across the country. I can’t fathom a country that turns their back on their veterans, particularly homeless veterans. Some of them are there because they can’t afford a home, some are homeless because of mental issues. Regardless, it’s our responsibility that if someone goes overseas, or even stays here, and fights for our country, fights for our citizens, it is incumbent upon us to take care of them.

Going back to my Responsible Homeowner Reward Program, we had a special program that we launched just for veterans. We know that veterans are great payers on their mortgages—they’re great homeowners. They’re very generous with their time. They’re very generous with their homes, but when you look at what we’re seeing, for example, folks coming across the border. I think the optic of being able to give somebody who crosses the border illegally opportunities for healthcare, opportunities for education, and opportunities for shelter. They’re giving people who cross the border opportunities for shelter, but we’re not actively seeking to take our homeless veterans and put them in a better position. One of the committees that I’ve asked to be on, should I be lucky enough to win this election in November, is our Veteran’s Committee. One homeless veteran, is one too many.

I know one of your signature accomplishments was the Responsible Homeowner Reward Program, back during the last crisis. Could you talk a little bit about what that did, and also any lessons that you took away from that program that you can apply going forward?
Thank you, in a 28-year private sector career, that program was the highlight of my career, personally. We stepped into a market that was clearly in trouble.

We provided a program that, free to the homeowner, helped guide them toward government and private-sector assistance programs to get help. When we walked out of the crisis, there were hundreds and hundreds of programs that were made available, both government and non-government programs.

It’s tough enough filling out these other applications where you need relief. In some cases, it could take days, weeks, or months. We put together a program that used a marriage of incentive theory and consumer marketing to bring those programs to homeowners who needed them, before they knew they needed them. That was the hallmark of the program.

It’s one of the reasons we won a Time Magazine Award. We used the same strategies that credit card companies use when they provide

rewards. We used the same strategies that create and find incentives, and disincentives for why borrowers and consumers do things. We knew that it would be in everyone’s best interest to keep a struggling homeowner in their home.

We also know that they may not be in a position to be able to afford those homes and make those mortgage payments. We worked very closely with the owners of the risk, the banks, and the government to show them that the risk/reward profile of giving a borrower earned principal forgiveness, in times of great negative equity, worked to everyone’s benefit.

We saw reductions in default rates of over 50%. We were able to take borrowers who wanted to stay in their home and create a series of low-priced alternatives and incentives to keep them there, at no cost to the borrower. We helped more than 10,000 veterans stay in their homes, without charging them. We helped more than 150,000 other homeowners—and not just homeowners, but owners of student loan borrowers, second-lien borrowers who thought that they had no time, that they had no opportunity to get themselves out of the situation they were in. We came in and said, “We can help you find an opportunity. We can get you to the finish line.”

That’s something I think about every single day, and when we’re elected to Congress, I want everyone who has the opportunity to own a home, and has the wherewithal and understands it’s a privilege, to buy a home. But also, somebody who’s struggling for whatever reason, whether it’s something that happened to them personally or something that’s going on in the economy, we want to give them the opportunity to stay in that home.

About Author: David Wharton

David Wharton, Editor-in-Chief at the Five Star Institute, is a graduate of the University of Texas at Arlington, where he received his B.A. in English and minored in Journalism. Wharton has nearly 20 years' experience in journalism and previously worked at Thomson Reuters, a multinational mass media and information firm, as Associate Content Editor, focusing on producing media content related to tax and accounting principles and government rules and regulations for accounting professionals. Wharton has an extensive and diversified portfolio of freelance material, with published contributions in both online and print media publications. He can be reached at [email protected].

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