Tag Archives: Request for Input

The Wayward Mission of the Federal Home Loan Bank System

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Adam Fagen CC BY-NC-SA 2.0

I recently submitted this comment to the Federal Housing Finance Agency in response to its request for input about the mission of the Federal Home Loan Bank System. It opens,

The Federal Housing Finance Agency (the “FHFA”) has requested Input regarding the regulatory statement of the Federal Home Loan Bank System’s (the “System”) mission to better reflect its appropriate role in the housing finance system. I commend the FHFA for being realistic about the System in its Request for Input; it acknowledges that there is a mismatch between its mission and its current operations.

The System’s operations do not do nearly enough to support the System’s stated mission of supporting the financing of housing. The System should recommit to that goal in measurable ways or its name and/or mission should be changed to better reflect its current operations.

While the System was originally designed to support homeownership, it has morphed into a provider of liquidity for large financial institutions. Banks like JPMorgan Chase & Co., Bank of America Corp., Citibank NA and Wells Fargo & Co. are among its biggest beneficiaries and homeownership is only incidentally supported by their involvement with it.

As part of the comprehensive review of the System, we should give thought to at least changing the name of the System so that it cannot trade on its history as a supporter of affordable homeownership. Or we should go even farther and give some thought to spinning off its functions into other parts of the federal financial infrastructure as its functions are redundant with theirs. But best of all would be a recommitment by the System to the measurable support of financing for housing.

This comment draws from a column (paywall) I had published when the FHFA first embarked on its reevaluation of the FLBLS.

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.

The Cost of Doing Nothing

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Yesterday, I wrote about the Securities Industry and Financial Markets Association (SIFMA)’s FHFA comment letter. Today I write about SIFMA’s comment letter in response to Treasury’s request for input relating to the future of the private-label securities market. Like the FHFA comment letter, this one is written with the concerns of SIFMA’s members in mind, no others, but it identifies many of the structural problems that exist in the housing finance system today.

If I were to identify a theme of the comments, it would be that the federal government has not moved with sufficient speed to establish a well delineated infrastructure for the housing finance market. Some commentators identify benefits of a slow approach — time to get consensus, time to get rules right, time to for trial and error before committing for the long term. Few identify the costs of regulatory uncertainty — failure to get buy-in for capital-intensive ventures, atrophy of existing resources, limited investor interest.

Now, SIFMA’s members want a vibrant private-label MBS market to make money. But a vibrant private-label MBS market is also good for the overall health of the mortgage market as it spreads risk to private MBS investors and reduces the footprints of the gargantuan GSEs and the government’s own FHA. After all, most of us want the private sector taking a lot of the risk, not the taxpayer.

Notwithstanding the strengths of SIFMA’s comment letter to Treasury in critiquing the status quo, I will highlight a few passages from it that hit a false note. The first relates to the role that private-label securities (PLS) have played

in funding mortgage credit where loan size or other terms may differ from those available in the Agency markets, or where economics dictate that PLS execution is superior. The PLS market may also be more innovative and flexible than the Agency markets in adapting to economic conditions or consumer preferences, or to changing capital markets appetite. (3)

This innovation has obviously cut both ways in terms of introducing new products that can help expand access to credit as well as expand access to credit on abusive terms. The latter way seems to have predominated during the most recent boom in PLS MBS.

The second one relates to assignee liability. SIFMA states that

Investors are concerned with the prospect of assignee liability stemming from violations of the ability-to-repay rules contained in Title XIV of Dodd-Frank and embodied in the CFPB’s implementing regulations. SIFMA has raised concerns with assignee liability in many forms over the years based on the fact that mortgage investors are not at the closing table with the lender and borrower, and should not be held liable for defects of which they have no knowledge or ability to prevent. While efforts were made by policymakers to provide some level of certainty through the inclusion of safe-harbor provisions, no safe harbor is entirely safe, and it is important to note that none of these provisions have been tested in court. It will be in litigation where the market learns the exact boundaries of the protections provided by any safe harbor. This potential liability for investors is likely to reduce the availability of higher-priced QM loans and non-QM loans, all else equal, due to higher required yields to compensate for the increased risk. (5-6)

This focus on assignee liability seems to be a red herring, one that SIFMA has floated for years. The risk from assignee liability provisions is not limitless and it can be modeled. Moreover, the notion that investors should face no liability because they are not at the closing table is laughable — without them, there would be no closing table at all. They paid for it, even if they are not in the room when the closing takes place.

The last one relates to the threatened use of eminent domain by some local governments to take underwater mortgages and refinance them to reflect current property valuations:

Investors have significant concerns with, and continuing distrust of the policy environment because of a sense that rules have been and continue to be changed ex-post. The threat by certain municipalities to use eminent domain to seize performing mortgage loans has been a focus of MBS investors for the last two years and would introduce a significant new risk into investing in PLS. These municipalities propose to cherry-pick loans from PLS trusts and compensate holders at levels far below the actual value of the loans. SIFMA’s investor members view such activity as an illegal taking of trust assets, and successful implementation of these plans would severely damage investor confidence in investing in PLS. (6)

This is another red herring as far as I am concerned.  The use of eminent domain is not an ex post legal maneuver. Rather, it is an inherent power of government that precedes the founding of this country. I understand that MBS investors don’t like it, but it is not some kind of newfangled violation of the rule of law as many investor advocates have claimed.

Notwithstanding its flaws, I recommend this letter as a trenchant critique of the housing system we have today.

Housing Finance Abhors A Vacuum

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The Securities Industry and Financial Markets Association (SIFMA) released their comment letter to the Federal Housing Finance Agency’s request for input relating to the role of the Fannie and Freddie guarantee fee (g-fee) in the housing finance market. While clearly reflecting the concerns of SIFMA’s members, the letter provides a thoughtful take on the complexities of the housing finance system. SIFMA writes,

Policymakers should not assume that increases in g-fees alone will lead to a significant increase in PLS issuance. Specific decisions on best execution for a given loan vary depending on the terms of the loan being originated. In some instances, a portfolio purchase may offer best execution, and in other instances the GSEs, private label MBS (PLS) or FHA may be optimal. Taken wholly in isolation, we do agree that increases in guarantee fees should cause originators to look toward other avenues to fund loans – in their portfolios, FHA, or in PLS. However, it is not so simple that an across the board increase in guarantee fees will result in a corresponding uptick in private-label securitization. To the extent GSE securitization becomes more expensive for issuers, PLS are one of a number of options, and not necessarily the most attractive in all instances. Today bank portfolios offer a more attractive funding alternative to the GSEs than PLS for most institutions. Of course, the appetite of banks for loans held in portfolio will vary with economic and regulatory conditions, and cannot always be assumed to comprise a certain percentage of the market.

There are also a number of reasons that increases to g-fees will not directly lead to increased PLS issuances that are not precisely quantifiable or directly related to cost. PLS issuers and investors face uncertainty as to the future shape of the mortgage market and questions related to compliance with the future regulatory regime. The re-regulation of the mortgage and securitization markets is not complete, and a number of consequential rulemakings are incomplete. These include but are not limited to risk retention and proposed revisions to the SEC’s Regulation AB. The final form of the definition of QRM and the rest of the risk retention rules will directly impact the economics of securitization. Regulation AB will impact the offering process, disclosure practices, and require fairly massive infrastructure adaptation at many RMBS issuers and sponsors. Of course, given that final rules are not available for any of these items, issuers and sponsors cannot begin this work. In this environment of uncertainty, it is difficult and indeed may be unwise for issuers or investors to expend resources to develop long-term issuing and investment platforms.

*     *     *

For these reasons, we do not believe FHFA or other policymakers should look at increases to GSE g-fees in a vacuum, and must consider them within the broader context of mortgage finance conditions. (6-7, footnotes omitted)

SIFMA is right to emphasize the regulatory uncertainty that its members face.  The federal government has not done enough to address this.  Housing finance, like nature, abhors a vacuum.  More on this tomorrow.

 

Fannie+Freddie=FRANNIE?!?

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The Federal Housing Finance Agency (FHFA) has posted a Request for Input on “the proposed structure for a Single Security that would be issued and guaranteed by Fannie Mae or Freddie Mac.” The FHFA’s press release states that

The Single Security project is intended to improve the overall liquidity of Fannie Mae and Freddie Mac mortgage-backed securities by creating a Single Security that is eligible for trading in the to-be-announced (TBA) market.  FHFA is requesting public input on all aspects of the proposed Single Security structure and is especially focused on issues regarding the transition from the current system to a Single Security.  Specific questions FHFA is asking relate to TBA eligibility, legacy Fannie Mae and Freddie Mac securities, potential industry impact of the Single Security initiative, and the risk of market disruption.

 The particular questions for which the FHFA invites feedback are

  1. What key factors regarding TBA eligibility status should be considered in the design of and transition to a Single Security?
  2. What issues should be considered in seeking to ensure broad market liquidity for the legacy securities?
  3. As discussed above, this is a multi-year initiative with many stakeholders. What operational, system, policy (e.g., investment guideline), or other effects on the industry should be considered?
  4. What can be done to ensure a smooth implementation of a Single Security with minimal risk of market disruption? (8)

The FHFA states it is most concerned with achieving “maximum secondary market liquidity,” so it is particularly interested “in views on how to preserve TBA eligibility and ensure that legacy MBS [mortgage-backed securities] and PCs [participation certificates] are fully fungible with the Single Security.” (8)

I must say that I am a little skeptical about the reasons for this move to a Single Security. It is unclear to me that this is an urgent need for the FHFA, the two companies, originating lenders or borrowers. While I have no doubt that it could slightly increase liquidity and slightly decrease the cost of credit, I do not see this move as having a dramatic effect on either.

I would say, though, that this move is consistent with an agenda to move toward a new model of government-supported housing finance, one that could contemplate an end to Fannie and Freddie as we know them and the beginning of a more utility-like securitizer like those proposed in the Johnson-Crapo and Corker-Warner bills. Perhaps the regulator will lead the way to housing finance reform when Congress and the Executive have failed to do so . . ..

Input is due by October 13, 2014.