Tag Archives: private capital

Treasury’s Take on Housing Finance Reform

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Treasury Secretary Mnuchin Being Sworn In

The Department of the Treasury released its Strategic Plan for 2018-2022. One of its 17 Strategic Objectives is to promote housing finance reform:

Support housing finance reform to resolve Government-Sponsored Enterprise (GSE) conservatorships and prevent taxpayer bailouts of public and private mortgage finance entities, while promoting consumer choice within the mortgage market.

Desired Outcomes

Increased share of mortgage credit supported by private capital; Resolution of GSE conservatorships; Appropriate level of sustainable homeownership.

Why Does This Matter?

Fannie Mae and Freddie Mac have been in federal conservatorship for nine years. Taxpayers continue to stand behind their obligations through capital support agreements while there is no clear path for the resolution of their conservatorship. The GSEs, combined with federal housing programs such as those at the Federal Housing Administration and the Department of Veterans Affairs, support more than 70 percent of new mortgage originations. Changes should encourage the entry of greater private capital in the U.S. housing finance system. Resolution of the GSE conservatorships and right-sizing of federal housing programs is necessary to support a more sustainable U.S. housing finance system. (16)

The Plan states that Treasury’s strategies to achieve these objectives are to engage “stakeholders to develop housing finance reform recommendations.” (17) These stakeholders include Congress, the FHFA, Fed, SEC, CFPB, FDIC, HUD (including the FHA), VA, Fannie Mae, Freddie Mac, the Association of State Banking Regulators as well as “The Public.” Treasury further intends to disseminate “principles and recommendations for housing finance reform” and plan “for the resolution of current GSE conservatorships.” (Id.)

This is all to the good of course, but it is at such a high level of generality that it tells us next to nothing. In this regard, Trump’s Treasury is not all that different from Obama and George W. Bush’s. Treasury has not taken a lead on housing finance reform since the financial crisis began. While there is nothing wrong with letting Congress take the lead on this issue, it would move things forward if Treasury created an environment in which housing finance reform was clearly identified as a priority in Washington. Nothing good will come from letting Fannie and Freddie limp along in conservatorship for a decade or more.

Bringing Housing Finance Reform over the Finish Line

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photo by LarryWeisenberg

Mike Milkin at Milkin Institute Global Conference

The Milkin Institute have released Bringing Housing Finance Reform over the Finish Line. It opens,

The housing finance reform debate has once again gained momentum with the goal of those involved to move forward with bipartisan legislation in 2018 that results in a safe, sound, and enduring housing finance system.

While there is no shortage of content on the topic, two different conceptual approaches to reforming the secondary mortgage market structure are motivating legislative discussions. The first is a model in which multiple guarantor firms purchase mortgages from originators and aggregators and then bundle them into mortgage-backed securities (MBS) backed by a secondary federal guarantee that pays out only after private capital arranged by each guarantor takes considerable losses (the multiple-guarantor model). This approach incorporates several elements from the 2014 Johnson-Crapo Bill and a subsequent plan developed by the Mortgage Bankers Association. Fannie Mae and Freddie Mac—the government-sponsored enterprises (GSEs)—would continue as guarantors, but would face new competition and would no longer enjoy a government guarantee of their corporate debt or other government privileges and protections.

The second housing finance reform plan is based on a multiple-issuer, insurance-based model originally proposed by Ed DeMarco and Michael Bright at the Milken Institute, and builds on the existing Ginnie Mae system (the DeMarco/Bright model). In this model, Ginnie Mae would provide a full faith and credit wrap on MBS issued by approved issuers and backed by loan pools that are credit-enhanced either by (i) a government program such as the Federal Housing Administration (FHA) or U.S. Department of Veterans Affairs (VA), or (ii) Federal Housing Finance Agency (FHFA)- approved private credit enhancers that arrange for the required amounts of private capital to take on housing credit risk ahead of the government guarantee. Fannie Mae and Freddie Mac would be passed through receivership and reconstituted as credit enhancement entities mutually owned by their seller/servicers.

While the multiple guarantor and DeMarco/Bright models differ in many ways, they share important common features; both address key elements of housing finance reform that any effective legislation must embrace. In the remainder of this paper, we first identify these key reform elements. We then assess some common features of the two models that satisfy or advance these elements. The final section delves more deeply into the operational challenges of translating into legislative language specific reform elements that are shared by or unique to one of the two models. Getting housing finance reform right requires staying true to high-level critical reform elements while ensuring that technical legislative requirements make economic and operational sense.  (2-3, footnotes omitted)

The report does a good job of outlining areas of broad (not universal, just broad) agreement on housing finance reform, including

  • The private sector must be the primary source of mortgage credit and bear the primary burden for credit losses.
  • There must be an explicit federal backstop after private capital.
  • Credit must remain available in times of market stress.
  • Private firms benefiting from access to a government backstop must be subject to strong oversight. (4-5)

We are still far from having a legislative fix to the housing finance system, but it is helpful to have reports like this to focus us on where there is broad agreement so that legislators can tackle the areas where the differences remain.

The FHFA’s Take on Housing Finance Reform

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FHFA Director Watt

Federal Housing Finance Agency Director Watt sent Federal Housing Finance Agency Perspectives on Housing Finance Reform to Senate Banking Chair Michael Crapo (R-ID) and Senator Sherrod Brown of Ohio, the top Democrat on that committee. There are no real surprises in it, but it does set forth a series of housing finance objectives that the FHFA supports:

• Preserve the 30-year fixed-rate, prepayable mortgage;

• End taxpayer bailouts for failing firms;

• Maintain liquidity in the housing finance market;

• Attract significant amounts of private capital to the center of the housing finance system through both robust equity capital requirements and credit risk transfer (CRT) participation;

• Provide for a single government-guaranteed mortgage-backed security that will improve the liquidity of the to-be-announced (TBA) market and promote a fair and competitive funding market for Secondary Market Entities (SMEs);

• Ensure access to affordable mortgages for creditworthy borrowers, sustainable rental options for families across income levels, and a focus on serving rural and other underserved markets;

• Provide a level playing field for institutions of all sizes to access the secondary market;

• Include tools for the regulator to anticipate and mitigate downturns in the housing market, including setting appropriate capital and liquidity requirements for SMEs, having prompt, corrective action authority for SMEs that are weak or troubled, and having authority to adjust CRT requirements as needed; and

• Provide a stable transition path that protects the housing finance market and the broader economy from potential disruptions and ensures that the new housing finance system operates as intended. (1)

The FHFA’s take on housing finance reform seems to be somewhat different from what various members of Congress are reportedly promoting. It is not clear though that the views of the FHFA are all that relevant to the Congressional leaders who are shaping the next housing finance reform bill. Nor do I expect that Director Watt’s views are particularly valued by the Trump Administration, given that he is a former Democratic member of Congress. That being said, Director Watt has always made it clear that it is Congress and not the FHFA that should be charting the path forward for housing finance reform.

While his views on the matter differ from those of some members of Congress, all of the relevant stakeholders seem to agree on the broad contours of what the 21st century’s housing finance infrastructure should look like. There should be an explicit guarantee to support the housing market during liquidity crises.  And the main elements of the current market, such as the thirty year fixed-rate mortgage, should be maintained. Here’s hoping that a bipartisan push can get this done this year.

Fannie, Freddie and Climate Change

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NOAA / National Climatic Data Center

The Housing Finance Policy Center at the Urban Institute issued its September 2017 Housing Finance At A Glance Chartbook. The introduction asks what the recent hurricanes tell us about GSE credit risk transfer. But it also has broader implications regarding the impact of climate-change related natural disasters on the mortgage market:

The GSEs’ capital markets risk transfer programs that began in 2013 have proven to be very successful in bringing in private capital, reducing the government’s role in the mortgage market and reducing taxpayer risk. Investor demand for Fannie Mae’s CAS and Freddie Mac’s STACR securities overall has been robust, in large part because of an improving economy and extremely low delinquency rates for loans underlying these securities.

Enter hurricanes Harvey, Irma and Maria. These three storms have inflicted substantial damage to homes in the affected areas. Many of these homes have mortgages backed by Fannie Mae and Freddie Mac, and many of these mortgages in turn are in the reference pools of mortgages underlying CAS and STACR securities. It is too early to know what the eventual losses might look like – that will depend on the extent of the damage, insurance coverage (including flood insurance), and the degree to which loss mitigation will succeed in minimizing borrower defaults and foreclosures.

Depending on how all of these factors eventually play out, investors in the riskiest tranches of CAS and STACR securities could witness marginally higher than expected losses. Up until Harvey, CRT markets had not experienced a real shock that threatened to affect the credit performance of underlying mortgages (except after Brexit, whose impact on the US mortgage market proved to be minimal). The arrival of these storms therefore in some ways is the first real test of the resiliency of credit risk transfer market.

It is also the first test for the GSEs in balancing the needs of borrowers with those of CRT investors. In some of the earlier fixed severity deals, investor losses were triggered when a loan went 180 days delinquent (i.e. experienced a credit event). Hence, forbearance of more than six months could trigger a credit event. Fannie Mae put out a press release that it would wait 20 months from the point at which disaster relief was granted before evaluating whether a loan in a CAS deal experienced a credit event. While most of Freddie’s STACR deals had language that dealt with this issue, a few of the very early deals did not; no changes were made to these deals. Both Freddie Mac and Fannie Mae have provided investors with an exposure assessment of the volume of affected loans in order to allow them to better estimate their risk exposure.

So how has the market responded so far? In the immediate aftermath of the first storm, spreads on CRT bonds generally widened by about 40 basis points, meaning investors demanded a higher rate of return. But thereafter, spreads have tightened by about 20 basis points, suggesting that many investors saw this as a good buying opportunity. This is precisely how capital markets are intended to work. If spreads had continued to widen substantially, that would have signaled a breakdown in investor confidence in future performance of these securities. The fact that that did not happen is an encouraging sign for the continued evolution of the credit risk transfer market.

To be clear, it is still very early to reasonably estimate what eventual investor losses will look like. As the process of damage assessment continues and more robust loss estimates come in, one can expect CAS/STACR pricing to fluctuate. But early pricing strongly indicates that investors’ underlying belief in these securities is largely intact. This matters because it tells the GSEs that the CRT market is resilient enough to withstand shocks and gives them confidence to further expand these offerings.

Three Paths to Housing Finance Reform

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photo by theilr

The Urban Institute’s Jim Parrott has posted Clarifying the Choices in Housing Finance Reform. It opens,

The housing finance reform debate has often foundered under the weight of its complexity. Not only is it a complicated topic, both in its substance and its politics, but the way that we talk about it makes the issues involved indecipherable to all but a few. Each proponent brings a different nomenclature, a different frame of reference, often an entirely different language, making it enormously difficult to sort through where there is agreement and where there is not.

As a case in point, three prominent proposals for reform have been put on the table in recent months: one offered by Lew Ranieri, Gene Sperling, Mark Zandi, Barry Zigas, and me (Promising Road Proposal); one offered by Ed DeMarco and Michael Bright (Milken Proposal); and one offered by the Mortgage Bankers Association (MBA Proposal). These proposals have been discussed and debated in many forums, each assessed for its respective merits, risks, and likelihood of passage in Congress, but each largely in isolation from one another. That is, they are not compared in any intelligible way, forcing those hoping to come to an informed view to choose among what appear to be entirely different visions of reform, without any easy way to make sense of the choice.

In this brief essay, I thus bring these three proposals together into a single framework, making it clearer what they share and where they differ. Once the explanatory fog is lifted, one can see that they actually share a great deal and that deciding among them is not prohibitively complex, but a matter of assessing two or three key differences. (1-2)

After a review of each proposal, Parrott finds that there are two critical differences between the three proposals.

  • Ginnie versus CSP. For the securitization infrastructure in the new system, Milken uses the Ginnie Mae infrastructure, while the MBA and our proposal both use the CSP.
  • What to do with Fannie and Freddie. The MBA would turn them into privately owned utilities that compete with other market participants over the distribution of the system’s non-catastrophic credit risk, Milken would turn them into lender-owned mutuals that do the same, and we would combine them with the CSP to distribute that risk and manage the system’s securitization.

With these distinctions in mind, the proposals can be much more easily compared across the criteria that should ultimately drive our decisions on housing finance reform:

  • Access to sustainable credit. Which best maintains broad access to mortgage loans for those in a financial position to be a homeowner at the lowest rates?
  • Protecting the taxpayer. Which best insulates taxpayers behind private capital, aligns incentives systemwide and addresses the too-big-to-fail risk that undermined the prior system?
  • Promoting healthy competition. Which best maximizes the kinds of competition that will improve options and services for consumers, lenders, and investors?
  • Ease of transition. Which provides the least disruptive, least costly path of reform? (7-8)

This is a very useful tool for understanding the choices that we face if we are to move beyond the limbo of Fannie and Freddie’s conservatorships.  One limitation is that Parrott does not address the Hensarling wing of the Republican Party which is looking to completely privatize the housing finance system for conforming mortgages. Given that Hensarling is the Chair of the House Financial Services Committee, he will have a powerful role in enacting any reform legislation.

I am not all that hopeful that Congress will be able to come up with a bill that can pass both houses in the near future.  But Parrott’s roadmap is helpful preparation for when we are ready.

Mortgage Bankers and GSE Reform

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photo by Daniel Case

The Mortgage Bankers Association has released GSE Reform Principles and Guardrails. It opens,

This paper serves as an introduction to MBA’s recommended approach to GSE reform. Its purpose is to outline what MBA views as the key components of an end state, the principles that MBA believes should be incorporated in any future system, the “guardrails” we believe are necessary in our end state, as well as emphasize the need to ensure a smooth transition to the new secondary mortgage market. (1)

While there is very little that is new in this document, it is useful, nonetheless, as a statement of the industry’s position. The MBA has promulgated the following principles for housing finance reform:

  • The 30-year, fixed-rate, pre-payable single-family mortgage and longterm financing for multifamily mortgages should be preserved.
  • A deep, liquid TBA market for conventional single-family loans must be maintained. Eligible MBS backed by a well-defined pool of single-family mortgages or multifamily mortgages should receive an explicit government guarantee, funded by appropriately priced insurance premiums, to attract global capital and preserve liquidity during times of stress. The government guarantee should attach to the eligible MBS only, not to the guarantors or their debt.
  • The availability of affordable housing, both owned and rented, is vitally important; these needs should be addressed along a continuum, incorporating both single- and multifamily approaches for homeowners and renters.
  • The end-state system should facilitate equitable, transparent and direct access to secondary market programs for lenders of all sizes and business models.
  • A robust, innovative and purely private market should be able to co-exist alongside the government-backed market.
  • Existing multifamily financing executions should be preserved, and new options should be permitted.
  • The end-state system should rely on strong, transparent regulation and private capital (including primary-market credit enhancement such as mortgage insurance [MI] and lender recourse, or other available forms of credit risk transfer) primarily assuming most of the risk.
  • While the system will primarily rely on private capital, there should be a provision for a deeper level of government support in the event of a systemic crisis.
  • There should be a “bright line” between the primary and secondary mortgage markets, applying to both allowable activities and scope of regulation.
  • Transition risks to the new end-state model should be minimized, with special attention given to avoiding any operational disruptions. (3-4)

This set of principles reflect the bipartisan consensus that had been developing around the Johnson-Crapo and Corker-Warner housing reform bills. The ten trillion dollar question, of course, is whether the Trump Administration and Congressional leaders like Jeb Hensarling (R-TX), the Chair of the House Banking Committee, are going to go along with the mortgage finance industry on this or whether they will push for a system with far less government involvement than is contemplated by the MBA.

Does Housing Finance Reform Still Matter?

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Ed DeMarco and Michael Bright

Ed DeMarco and Michael Bright

The Milken Institute’s Michael Bright and Ed DeMarco have posted a white paper, Why Housing Reform Still Matters. Bright was the principal author of the Corker-Warner Fannie/Freddie reform bill and DeMarco is the former Acting Director of the Federal Housing Finance Agency. In short, they know housing finance. They write,

The 2008 financial crisis left a lot of challenges in its wake. The events of that year led to years of stagnant growth, a painful process of global deleveraging, and the emergence of new banking regulatory regimes across the globe.

But at the epicenter of the crisis was the American housing market. And while America’s housing finance system was fundamental to the financial crisis and the Great Recession, reform efforts have not altered America’s mortgage market structure or housing access paradigms in a material way.

This work must get done. Eventually, legislators will have to resolve their differences to chart a modernized course for housing in our country. Reflecting upon the progress made and the failures endured in this effort since 2008, we have set ourselves to the task of outlining a framework meant to advance the public debate and help lawmakers create an achievable plan. Through a series of upcoming papers, our goal will be to not just foster debate but to push that debate toward resolution.

Before setting forth solutions, however, it is important to frame the issues and state why we should do this in the first place. In light of the growing chorus urging surrender and going back to the failed model of the past, our objective in this paper is to remind policymakers why housing finance reform is needed and help distinguish aspects of the current system that are worth preserving from those that should be scrapped. (1)

I agree with a lot of what they have to say.  First, we should not go back to “the failed model of the past,” and it amazes me that that idea has any traction at all. I guess political memories are as short as people say they are.

Second, “until Congress acts, the FHFA is stuck in its role of regulator and conservator.” (3) They argue that it is wrong to allow one individual, the FHFA Director, to dramatically reform the housing finance system on his own. This is true, even if he is doing a pretty good job, as current Director Watt is.

Third, I agree that any reform plan must ensure that the mortgage-backed securities market remain liquid; credit remains available in all submarkets markets; competition is beneficial in the secondary mortgage market.

Finally, I agree with many of the goals of their reform agenda: reducing the likelihood of taxpayer bailouts of private actors; finding a consensus on access to credit; increasing the role of private capital in the mortgage market; increasing transparency in order to decrease rent-seeking behavior by market actors; and aligning incentives throughout the mortgage markets.

So where is my criticism? I think it is just that the paper is at such a high level of generality that it is hard to find much to disagree about.  Who wouldn’t want a consensus on housing affordability and access to credit? But isn’t it more likely that Democrats and Republicans will be very far apart on this issue no matter how long they discuss it?

The authors promise that a detailed proposal is forthcoming, so my criticism may soon be moot. But I fear that Congress is no closer to finding common ground on housing finance reform than they have been for the better part of the last decade. The authors’ optimism that consensus can be reached is not yet warranted, I think. Housing reform may not matter because the FHFA may just implement a new regime before Congress gets it act together.