Tag Archives: guarantee

Spreading Mortgage Credit Risk

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photo by A Syn

The Federal Housing Finance Agency has released the Single-Family Credit Risk Transfer Progress Report. Important aspects of Fannie and Freddie’s future are described in this report. It opens,

Since 2012, the Federal Housing Finance Agency (FHFA) has set as a strategic objective that Fannie Mae and Freddie Mac share credit risk with private investors. While the Enterprises have a longstanding practice of sharing credit risk on certain loans with primary mortgage insurers and other counterparties, the credit risk transfer transactions have taken further steps to share credit risk with private market participants. Since the Enterprises were placed in conservatorship in 2008, they have received financial support from the U.S. Department of the Treasury under the Senior Preferred Stock Purchase Agreements (PSPAs). The Enterprises’ credit risk transfer programs reduce the overall risk to taxpayers under these agreements.

These programs have made significant progress since they were launched in 2012 and credit risk transfer transactions are now a regular part of the Enterprises’ businesses. This progress is reflected in FHFA’s 2016 Scorecard for Fannie Mae, Freddie Mac, and Common Securitization Solutions (2016 Scorecard), which sets the expectation that the Enterprises will transfer risk on 90 percent of targeted single-family, 30-year, fixed-rate mortgages. FHFA works with the Enterprises to ensure that credit risk transfer transactions are conducted in an economically sensible way that effectively transfers risk to private investors.

This Progress Report provides an overview of how the Enterprises share credit risk with the private sector, including through primary mortgage insurance and the Enterprises’ credit risk transfer programs. The discussion includes year-end 2015 data, a discussion of which Enterprise loan acquisitions are targeted for the credit risk transfer programs, and an overview of investor participation information. (1, footnotes omitted)

This push to share credit risk with private investors is a significant departure from the old Fannie/Freddie business model and it should do just what it promises: reduce taxpayer exposure to credit risk for the trillions of dollars of mortgages the two companies guarantee through their mortgage-backed securities. That being said, this is a relatively new initiative and the two companies (and the FHFA, as their conservator and regulator) have to navigate a lot of operational issues to ensure that this transfer of credit risk is priced appropriately.

There are also some important policy issues that have not been settled. The FHFA has asked for feedback on a series of issues in its Single-Family Credit Risk Transfer Request for Input, including,

  • how to “develop a deeper mortgage insurance structure” (RfI, 17)
  • how to develop credit risk transfer strategies that work for small lenders (RfI, 18)
  • how to price the fees that Fannie and Freddie charge to guarantee mortgage-backed securities (RfI, 19)

Congress has abdicated its responsibility to implement housing finance reform, so it is left up to the FHFA to make it happen. Indeed, the FHFA’s timeline has this process being finalized in 2018. The only way for the public to affect the course of reform is through the type of input the FHFA is now seeking:

FHFA invites interested parties to provide written input on the questions listed [within the Request for Input] 60 days of the publication of this document, no later than August 29, 2016. FHFA also invites additional input on the topics discussed in this document that are not directly responsive to these questions.

Input may be submitted electronically using this response form. You may also want to review the FHFA’s update on Implementation of the Single Security and the Common Securitization Platform and its credit risk transfer page as it has links to other relevant documents.

Road to GSE Reform

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photo by Antonio Correa

A bevy of housing finance big shots have issued a white paper, A More Promising Road to GSE Reform. The main objective of the proposal

is to migrate those components of today’s system that work well into a system that is no longer impaired by the components that do not, with as little disruption as possible. To do this, our proposal would merge Fannie and Freddie to form a single government corporation, which would handle all of the operations that those two institutions perform today, providing an explicit federal guarantee on mortgage-backed securities while syndicating all noncatastrophic credit risk into the private market. This would facilitate a deep, broad and competitive primary and secondary mortgage market; limit the taxpayer’s risk to where it is absolutely necessary; ensure broad access to the system for borrowers in all communities; and ensure a level playing field for lenders of all sizes.

The government corporation, which here we will call the National Mortgage Reinsurance Corporation, or NMRC, would perform the same functions as do Fannie and Freddie today. The NMRC would purchase conforming single-family and multifamily mortgage loans from originating lenders or aggregators, and issue securities backed by these loans through a single issuing platform that the NMRC owns and operates. It would guarantee the timely payment of principal and interest on the securities and perform master servicing responsibilities on the underlying loans, including setting and enforcing servicing and loan modification policies and practices. It would ensure access to credit in historically underserved communities through compliance with existing affordable-housing goals and duty-to-serve requirements. And it would provide equal footing to all lenders, large and small, by maintaining a “cash window” for mortgage purchases.

The NMRC would differ from Fannie and Freddie, however, in several important respects. It would be required to transfer all noncatastrophic credit risk on the securities that it issues to a broad range of private entities. Its mortgage-backed securities would be backed by the full faith and credit of the U.S. government, for which it would charge an explicit guarantee fee, or g-fee, sufficient to cover any risk that the government takes. And while the NMRC would maintain a modest portfolio with which to manage distressed loans and aggregate single- and multifamily loans for securitization, it cannot use that portfolio for investment purposes. Most importantly, as a government corporation, the NMRC would be motivated neither by profit nor market share, but by a mandate to balance broad access to credit with the safety and soundness of the mortgage market. (2-3, footnotes omitted)

The authors of the white paper are

  • Jim Parrott, former Obama Administration housing policy guru
  • Lewis Ranieri, a Wall Street godfather of the securitized mortgage market
  • Gene Sperling,  Obama Administration National Economic Advisor
  • Mark Zandi, Moody’s Analytics chief economist
  • Barry Zigas, Director of Housing Policy at Consumer Federation of America

While I think the proposal has a lot going for it, I think that the lack of former Republican government officials as co-authors is telling. Members of Congress, such as Chair of the House Financial Services Committee Jeb Hensaerling  (R-TX), have taken extreme positions that leave little room for the level of government involvement contemplated in this white paper. So, I would say that the proposal has a low likelihood of success in the current political environment.

That being said, the proposal is worth considering because we’ll have to take Fannie and Freddie out of their current state of limbo at some point in the future. The proposal builds on on current developments that have been led by Fannie and Freddie’s regulator and conservator, the Federal Housing Finance Agency. The FHFA has required Fannie and Freddie to develop a Common Securitization Platform that is a step in the direction of a merger of the two entities. Moreover, the FHFA’s mandate that Fannie and Freddie’s experiment with risk-sharing is a step in the direction of the proposal’s syndication of “all noncatastrophic credit risk.” Finally, the fact that the two companies have remained in conservatorship for so long can be taken as a sign of their ultimate nationalization.

In some ways, I read this white paper not as a proposal to spur legislative action, but rather as a prediction of where we will end up if Congress does not act and leaves the important decisions in the hands of the FHFA. And it would not be a bad result — better than what existed before the financial crisis and better than what we have now.

Feds Financing Multifamily

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Brett VA

The Congressional Budget Office has released The Federal Role in the Financing of Multifamily Rental Properties. The report opens,

Multifamily properties—those with five or more units— provide shelter for approximately one-third of the more than 100 million renters in the United States and account for about 14 percent of all housing units. Mortgages carrying an actual or implied federal guarantee have been an important source of financing for acquiring, developing, and rehabilitating multifamily properties, particularly after the collapse in house prices and credit availability that accompanied the 2008–2009 recession. According to the Federal Reserve, the share of outstanding multifamily mortgages carrying such a guarantee increased by 10 percentage points, from 33 percent at the beginning of 2005 to 43 percent at the end of the third quarter of 2014. (A slightly larger increase of about 16 percentage points occurred in the federal government’s market share of the much larger single-family market.) Such guarantees are made by a variety of entities, and some policymakers are looking for ways to make the federal government’s involvement more effective. Other policymakers have expressed concern about that expanded federal role and are looking at ways to reduce it. (1)

This debate is, of course, key to housing policy more generally: to what extent should the government be involved in the provision of credit in that sector?

This report does a nice job of summarizing the state of the multifamily housing sector, particularly since the financial crisis. It provides an overview of federal mortgage guarantees for multifamily projects and reviews the choices that Congress faces when it decides to determine Fannie and Freddie’s fate. That is, should we have a federal agency guarantee multifamily mortgages; take a hybrid public/private approach; authorize a federal guarantor of last resort; or take a largely private approach?

We should start by asking if there is a market failure in the housing finance sector and then ask how the government should intercede to correct that market failure. My own sense is that we intercede too much and we should move toward a federal guarantor of last resort with additional support for the low- and moderate-income subsector of the market.

 

 

 

Friday’s Government Reports Roundup

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  • The Federal Housing Finance Agency (FHFA) released its results to the Fannie Mae and Freddie Mac Guarantee Fee Review. Following the release, the FHFA announced that the fees would remain the same with modest adjustments.
  • HUD released the 2009-2011 National Rental Dynamics Reports, which tracks changes in rental housing affordability.

Reiss on FHA Mortgages for First Timers

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MainStreet quoted me in FHA Loans Can Be A Good Option for First-Time Homebuyers. It opens,

FHA loans can be an attractive option for consumers purchasing their first home, because they require much smaller down payments.

First-time homebuyers often consider these Federal Housing Administration loans, because they do not require a large down payment or high FICO scores unlike traditional 30-year fixed mortgages. Given that young households tend not to have the savings for a substantial down payment, they can be an attractive option, David Reiss, a law professor at Brooklyn Law School.

Because FHA loans are mortgages insured by the Federal Housing Administration, this guarantee reduces the risk of “loss of principal for lenders, which is advantageous for borrowers,” said Joseph Cahoon, director of the Folsom Institute for Real Estate at Southern Methodist University’s Cox School of Business School in Dallas.

This results in some consumers being able to put down as little as 3.5% for a down payment towards the purchase of a new home. For many first-time Millennial homebuyers, the prospect of saving 20% for a standard down payment has been challenging during the past several years because of a combination of low growth in wages and high student loan debt.

“For those borrowers with good credit, FHA insured loans offer a good pathway to home ownership, he said.

*     *     *

“Homebuyers should compare all of their options before going with an FHA mortgage,” Reiss said.

The Rescue of Fannie and Freddie

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Federal Reserve researchers, W. Scott Frame, Andreas Fuster, Joseph Tracy and James Vickery, have posted a staff report, The Rescue of Fannie Mae and Freddie Mac. The abstract reads,

We describe and evaluate the measures taken by the U.S. government to rescue Fannie Mae and Freddie Mac in September 2008. We begin by outlining the business model of these two firms and their role in the U.S. housing finance system. Our focus then turns to the sources of financial distress that the firms experienced and the events that ultimately led the government to take action in an effort to stabilize housing and financial markets. We describe the various resolution options available to policymakers at the time and evaluate the success of the choice of conservatorship, and other actions taken, in terms of five objectives that we argue an optimal intervention would have fulfilled. We conclude that the decision to take the firms into conservatorship and invest public funds achieved its short-run goals of stabilizing mortgage markets and promoting financial stability during a period of extreme stress. However, conservatorship led to tensions between maximizing the firms’ value and achieving broader macroeconomic objectives, and, most importantly, it has so far failed to produce reform of the U.S. housing finance system.

 This staff report provides a nice overview of the two companies since the financial crisis. I was particularly interested by a couple of sections. First, I found the discussion of receivership versus conservatorship helpful. Second, I liked how it outlined the five objectives for an optimal intervention:

(i) Fannie Mae and Freddie Mac would be enabled to continue their core securitization and guarantee functions as going concerns, thereby maintaining conforming mortgage credit supply.

(ii) The two firms would continue to honor their agency debt and mortgage-backed securities obligations, given the amount and widely held nature of these securities, especially in leveraged financial institutions, and the potential for financial instability in case of default on these obligations.

(iii) The value of the common and preferred equity in the two firms would be extinguished, reflecting their insolvent financial position.

(iv) The two firms would be managed in a way that would provide flexibility to take into account macroeconomic objectives, rather than just maximizing the private value of their assets.

(v) The structure of the rescue would prompt long-term reform and set in motion the transition to a better system within a reasonable period of time. (14-15)

You’ll have to read the paper to see how they evaluate the five objectives in greater detail.

Reforming Fannie & Freddie’s Multifamily Business

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Mark Willis & Andrew Neidhardt’s article, Reforming the National Housing Finance System: What’s at Risk for the Multifamily Rental Market if Fannie Mae and Freddie Mac Go Away?, was recently published in a special issue of the NYU Journal of Law & Business. Most of the ink spilled about the reform of Fannie and Freddie addresses their single-family lines of business. The single-family business is much bigger, but the multifamily business is also an important part of what they do.

The author’s conclude that

Reform of the nation’s housing finance system needs to be careful not to disrupt unnecessarily the existing multifamily housing market. The near collapse of Fannie and Freddie’s single-family business over five years ago resulted in conservatorship and has spawned calls for their termination. While a general consensus has since emerged that Fannie and Freddie should be phased out over time, no consensus exists as to which, if any, of their functions need to be replaced in order to preserve the affordability and availability of housing in general, and multifamily rentals in particular.

On the multifamily side, Fannie and Freddie have built specialized units using financing models that involve private sector risk-sharing (i.e., DUS lender capital at risk or investors holding subordinate tranches of K-series securities) and that have resulted in low default rates and limited credit losses. These units have benefited from an implicit government guarantee of their corporate debt, which has expanded their access to capital and lowered its cost. As a result of the implicit guarantee, Fannie and Freddie have been able to: 1) offer longer term mortgages than generally available from banks, 2) provide countercyclical support to the rental market by funding new mortgages throughout the recent housing and economic downturn, and 3) ensure that the vast majority of the mortgages they fund offer rents affordable to households earning less than even 80% of area median income.

The potential for moral hazard can be reduced without disrupting the multifamily housing market simply by separating out and nationalizing the government guarantee It would then be possible to: 1) spin off the multifamily businesses of Fannie and Freddie into self-contained entities and 2) create an explicit government guarantee, offered by a government entity, and paid for through premiums on the insured MBS. The first step could happen now with FHFA authorization. These new subsidiaries could also begin to pay their respective holding companies for providing the guarantee on their MBS. The second step requires Congressional legislation. Once the public guarantor is up and running, the guarantee would be purchased from it and these subsidiaries could then be sold to private investors. As for other reforms that would explicitly restrict market access to the government guarantee, the best approach would be to first test the private sector’s appetite for risk on higher-end deals. (539-40)

This article has a lot to offer in terms of analyzing how Fannie and Freddie’s multifamily business is distinct from their single-family business. But I do not think that it fully makes the case that the multifamily sector suffers from some sort of market failure that requires so much government intervention as it advocates. I suspect that private capital could be put into a first loss position for much more of the lending in this sector. The government could continue to support the low- and moderate-income rental market without being on the hook for the rest of the multifamily market.