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GSE Reform Shuffles to the Exits

September 09, 2019

More than a decade after Fannie Mae and Freddie Mac were placed into conservatorship at the height of the financial crisis, the Trump Administration’s Treasury Department on September 5 released its long-awaited report on mortgage finance reform.  Importantly, the report endorses a government role in supporting long term fixed rate mortgages and a federal guarantee of mortgage backed securities.  The report’s other central driving principles are a commitment to move the two companies out of the conservatorship and shrink their role and that of any possible additional chartered guarantors in the overall housing finance market.

But the report lands in an environment where there is no likely path to legislative action on Fannie Mae and Freddie Mac, and its organization and recommendations reflect this reality.  So after many conferences, meetings, hearings, white papers and recommendations from every point of the compass, it appears that Fannie Mae’s and Freddie Mac’s role in the mortgage market will end pretty much as it began – with a duopoly of congressionally chartered private shareholder owned companies dominating the secondary market.

The result for consumers will be a mixed bag.  On the one hand, there will continue to be support for long term fixed rate mortgages; underwriting standards for most mortgages will be broadly uniform and driven by Fannie and Freddie; global and national investors will confidently provide the cash to fuel US homeownership and rental housing finance; and this duopoly will be constrained in some measure by stricter regulation than in the past and with an enduring requirement to meet specific housing goals and investments in targeted markets through the duty to serve requirements adopted in 2008.  On the other hand, mortgages are likely to become more expensive for more borrowers; it will be harder for low wealth consumers with less than sterling credit to get a mortgage outside of FHA, VA or other totally government supported lending; and managing the inherent conflicts between public purpose and private shareholders will continue to be a challenge for FHFA and Congress.

Legislative Recommendations

The report contains both legislative and administrative proposals.  The legislative proposals fail to address the specific hurdles that have stymied even bipartisan legislative efforts in the last 10 years, which have included a lack of agreement about how to manage access and affordability for LMI borrowers in any new legislation.  They would eliminate the current regime of housing goals and specific duty to serve requirements with something like a plan advanced in draft Senate legislation last year that would scrape a fee off guaranteed securities and give the money to HUD for specific on-budget appropriated programs aimed at LMI borrowers.  This was a key reason for the failure of last year’s Corker Warner reboot, and there is no support for this approach among Democratic leaders in the House or Senate.  The report offers no further insight into how this recommendation would fare any better now, especially with a Democrat controlled House, or how to modify it to bring any Democratic support. Early highly negative responses from both House Financial Services Committee Chair Maxine Waters (D-CA) and Senate Banking Committee Ranking Member Sherrod Brown (D-OH) reinforce this.  The report also notes the challenge in a multi-guarantor system of ensuring that guarantors serve a national rather than smaller geographic areas but fails to offer any usefully specific ways to resolve this problem.

Administrative Proposals

Given the small chance of legislative action, the report’s meatier administrative recommendations move front and center.  These amount to a roadmap for recapitalizing Fannie and Freddie and then releasing them from conservatorship. Given the broad powers granted to FHFA in the HERA amendments of 2008 and in the terms of the conservatorship, there is little to stop FHFA from moving forward as outlined in this report.

Under this approach the current affordable housing approach – with the housing goals, duty to serve regime, and the 4.2 basis point assessment to fund the Housing Trust Fund and Capital Magnet Fund --would remain in place, although the report urges consideration of undefined “alternative approaches.” The proposal also would keep in place the Preferred Stock Purchase Agreements (PSPAs) through which Treasury invested nearly $200 billion to shore up the companies’ capital, maintaining their explicit guarantee.  But recapitalization would begin through an end to the so-called Net Worth Sweep, which in turn replaced the original quarterly dividend on the PSPAs.  The sweep would be replaced with a periodic commitment fee to pay for the PSPAs’ guarantee.

The report promotes administrative actions that would reduce the GSEs’ role in the market. This is promoted as a way to “crowd in” private capital that has remained largely on the sidelines since the crisis.  But doing so risks constraining mortgage access at a time when the larger economy is already sending weakening signals.  The report therefore basically punts on whether and when to take such actions as restricting GSE financing of vacation homes, investor properties, cash-out refinances, among other products, directing FHFA to closely examine such moves.

The report also endorses a continuing role for the GSEs and any successors in financing multifamily rental housing but expresses concern that they have too big a footprint in the market today, again suggesting limitations that could be pursued by FHFA as administrative actions. 

The report also highlights the overlaps that currently exist between the GSEs’ market and that of other federally supported guarantors like the FHA and urges both legislative and administrative action to reduce the overlap between the markets they serve. Examples of such overlap cited in the Treasury report include high LTV Fannie and Freddie loans, FHA loans for cash out refinancings, and loans refinanced from conventional to FHA mortgages.   A companion report from HUD also highlights the need for better coordination and market share management, and recommends legislative action to establish “…FHA, VA and USDA…as the sole source of low downpayment finance for borrowers not served by the conventional mortgage market.” But it’s not clear what other sources this action would restrict.

HUD Report

The HUD report also outlines a legislative and administrative track for reform.  The key legislative recommendation would set up FHA as an autonomous corporation rather than the government agency it now is.  Again, Congress is unlikely to move on this recommendation although similar recommendations have been made by several commentators across the political spectrum, dating back at least to a housing commission report in 2002.

The report also recommends administrative steps for HUD to establish a “Housing Sustainability Scorecard” to monitor its insurance programs; further restrict down payment assistance from private sources, citing poorer performance among loans with such a feature; refine and finalize a “defect taxonomy” to give lenders better guidance on the relative penalties likely to result from mistakes in FHA insurance placement; make the FHA loss mitigation process less cumbersome; clarify loan conveyance procedures to reduce delays and confusion; and work with the CFPB to reduce loss mitigation costs. 

Next Steps

The Senate Banking Committee has scheduled a hearing with Treasury Secretary Mnuchin, FHFA Director Calabria and HUD Secretary Ben Carson on September 10 to review the report.  The hearing most likely will reinforce the lack of sufficient Senate consensus on key issues like assuring broad access and affordability.  How quickly and how aggressively FHFA and Treasury move on the administrative recommendations in the report may depend in part on the tenor and questions raised at the hearing.  But the most likely outcome is a renewed effort by Director Calabria to move forward on the administrative recommendations as quickly as possible. 

This blog also appeared on CFA's website.

New Mortgage Finance Platform Should Be Public Asset

June 09, 2019

On June 3 Fannie Mae and Freddie Mac carried out the most momentous change in mortgage finance since the emergence of mortgage backed securities in the 1980s and shifted their bond production into a single security, the so-called Uniform MBS (UMBS).  If you weren’t paying attention, this passed without notice, which is a remarkable and impressive thing given the enormity and complexity of the move.

But it now confronts policy makers with a critical choice. Do they let Fannie and Freddie keep this upgrade of what will now become the nation’s primary securitization infrastructure? Or do they take the next logical step and put this critical infrastructure into the public’s hands? My co-authors and I in 2016 proposed A More Promising Road to Mortgage Finance Reform, in which precisely such a market utility , owned by a new government owned corporation, would take over all of the issuance functions for government supported lending, while relying on a broad array of private credit insurers to protect the government from mortgage loss risk in all but the most exigent economic circumstances. The successful launch of the UMBS makes the case for this path more compelling than ever.

The bonds were issued by the Common Securitization Platform (CSP) that the two companies developed through a joint venture supervised by the Federal Housing Finance Administration (FHFA). The change from bonds issued separately by the two companies was largely invisible to the general public, and probably to most congressional members who ultimately are responsible for the charters that govern the two companies.  By all reports, it happened without incident – bonds were created, investors bought them, and worldwide investment in the US housing market continued without any hiccups.  But not everyone is thrilled with the notion that this new platform and security will further strengthen the companies’ hold over the mortgage market.  The companies’ ownership of the platform has already sparked demands by some mortgage industry players to open the system for others to use, and to force Fannie and Freddie to share currently proprietary data about their current MBS inventory so others can compete more effectively with them through the platform.

The successful launch of the UMBS presents the perfect opportunity to adopt our plan and move the platform into public ownership.  Leaving the platform with Fannie and Freddie would cement their too big to fail status and place its ongoing support for mortgage finance in the hands of shareholder owned companies with powerful profit maximizing incentives – companies that have shown that they can fail and indeed are too big to be allowed to fail in their fully private forms.  Taking the public ownership approach would remove this critical instrument of national economic security from private ownership and exploitation and insulate it from the risks of a repeat failure of the companies.  If the platform is owned by a public corporation, it would continue to function even if one or more entities providing the credit insurance behind the bonds’ assets failed.  Rather than betting the whole mortgage finance system on the solvency of a couple of private companies, our plan would protect the system’s critical “plumbing” while leaving genuinely private entities to shoulder the mortgage risks.

A single security and a single issuing platform have been a feature of every serious proposal for a post-conservatorship mortgage finance system.  Until now, it has been only theoretically possible.  Now it is a reality.  There will never be a better time to take the next logical step to make this resource fully protected and available for securities backed by any qualified credit insurer by putting it in a publicly owned corporation.

This also appeared on Consumer Federation of America's website.

White House Wades into Mortgage Finance Reform

March 28, 2019

President Trump issued a memorandum on March 27 directing the Treasury, HUD, VA and USDA to develop a comprehensive plan for reform of the mortgage finance system, including both administrative and legislative actions as necessary.  The memorandum specifically tasks Treasury with developing a plan to end the conservatorship of Fannie Mae and Freddie Mac “upon completion of specified reforms.”

While a White House directive focused on the mortgage finance system is a welcome and news making event, a close read of the memo suggests that there is much work to be done and little new ground broken so far.  The memo is essentially a directive to “plan for a plan.”  The most notable feature of the memorandum is its apparent expectation that Fannie Mae and Freddie Mac, in some form, will remain the key entities in the government’s support for mortgage finance and the apparent commitment to use administrative actions through the Federal Housing Finance Agency (FHFA) to get there.  This is in marked contrast to other plans, including from Senate Banking Committee Chair Mike Crapo (R-ID) and House Financial Services Committee Chairwoman Maxine Waters (D-CA), in the past, which anticipated replacing Fannie and Freddie with some new form of federal guarantors.

Fannie Mae and Freddie Mac (the GSEs) were put into conservatorship in 2008 as a result of the broader financial crisis. The Treasury provided significant capital to support their ongoing operations in exchange for Senior Preferred Shares and warrants for nearly 80 percent of the outstanding common shares.  The preferred shares carried a 10 percent dividend, compounding quarterly.  The Treasury subsequently replaced the dividend with a sweep of all net earnings, which continues to this day and has contributed nearly $300 billion to the US Treasury.

Parameters for reform

The White House memorandum outlines a series of policy parameters and aspirations for the anticipated plan. These closely mirror many of the broad and important considerations and principles that have appeared in a series of reform proposals in the last 10 years.  These include the following provisions:

1. Facilitating competition in the housing finance market
2. Safeguarding the GSEs’ safety and soundness and minimizing their risk to taxpayers
3. Appropriate compensation for any explicit or implicit support provided to them or the secondary market by the government
4. Preserving access to 30-year fixed rate mortgages
5. Maintaining access to the system by lenders of all sizes, charter types and geographic locations, including a cash window for loan sales
6. Appropriate capital and liquidity requirements
7. Increasing competition in the secondary market by authorizing the approval of new guarantors of conventional mortgage loans

         Mitigating risk undertaken by the GSEs

1. Recommending appropriate size and risk profiles for the GSEs’ retained mortgage and investment portfolios
2. Defining the GSEs’ role in multifamily mortgage finance
3. Defining the mission of the Federal Home Loan Bank (FHLB) system and its role in supporting federal housing finance
4. Defining the GSEs’ role in promoting affordable housing, without duplicating support provided by the FHA or other federal mortgage credit programs
5. Setting the conditions necessary for termination of the conservatorship.

Notably, the memo goes on to direct the HUD Secretary develop a plan that will ensure “…that FHA and GNMA assume primary responsibility for providing housing finance support to low- and moderate- income families that cannot be fulfilled through traditional underwriting;” and reducing taxpayer exposure at FHA through improved risk management and program and product design. The focus on strengthening FHA is urgently needed but will require significant new funding to succeed, on which the memo is silent.  It is also unclear how this directive would shift from the current market, where FHA’s market share has grown while the GSEs’ credit box has tightened and its pricing for low down payment, moderate credit borrowers has escalated. 

The memo also is silent on what form a future ongoing federal guarantee in the system would take – only on the securities issued in a new system, as every major proposal to date has done, or on post conservatorship GSEs as entities themselves.  This latter choice would be closer to the pre-crisis GSE status, which has found little support since the crisis.   

Is This a Step Forward?

The broad directives in the memo echo recommendations and principles that have been proposed in numerous forums over the last ten years from both Republican and Democratic sponsors, and outside groups including lenders, consumer advocates and think tanks across the ideological spectrum.  It provides no details on how the enunciated principles will be executed or how the various obstacles that have prevented reforms consistent with these principles to date will be overcome. It is a plan to come up with a plan. 

A provocative and welcome aspect of the memo is its explicit focus on the full range of the federal government’s various supports and interventions in the housing market, through the GSEs, Federal Home Loan Banks as well as FHA (and presumably VA and Rural Housing Services) mortgage guarantees rather than a narrow focus on only the GSEs. 

The memo also reiterates the importance of defining any post-conservatorship role for the GSEs or new competitors in meeting affordable housing needs.  But it also seems to expect FHA to primarily shoulder this task.  Unfortunately, the memo describes FHA as serving low- and moderate-income borrowers – FHA has no income limits -- rather than those with low wealth and less robust credit histories.  While FHA’s book does skew to lower income borrowers it also includes higher income households who benefit from its mission-focused products, particularly in communities of color, where income and wealth are not always directly correlated thanks to decades of de jure and de facto discrimination in mortgage lending. 

The memorandum was published on the second day of hearings in the Senate Banking Committee on mortgage finance reform. These hearings showcased the wide range of specific proposals that have been circulating for years but they did not offer a clear path forward for legislative action.  House Financial Services Committee Chairwoman Maxine Waters authored a proposal for comprehensive GSE reform some years ago, but it is unclear how high a priority this will be for the committee. 

The Administration’s newly articulated commitment to some kind of reform will add additional energy to this discussion, and its focus on potential administrative actions may mean that change in the status quo is closer than it was at the beginning of the week.

This post also appears on the Consumer Federation of America's website.  

New House Mortgage Reform Bill: Federal Guarantee, No Affordable Housing Requirements

September 10, 2018

House Financial Services Committee Chair Jeb Hensarling (R-TX) released a section by section summary of yet another mortgage finance reform bill on September 6, 2018.  He was joined by Reps. John Delaney (D-MD) and Jim Himes (D-NY) as cosponsors.

The drop marks Hensarling’s final surrender to the inevitable endorsement of a full faith and credit guarantee for conventional mortgage backed securities.  That is a welcome headline.  But specific legislative provisions described in the summary would codify a system where wealthy, high credit quality borrowers would be served through the new guarantee system through government approved credit enhancers and those with lower credit and incomes needing lower down payments would be relegated to the government’s credit insurance programs like FHA, VA or priced out of the market altogether.  And while the draft makes a nod to the need for the new “Private Credit Enhancers” at the heart of the proposal to make credit broadly available across diverse borrowers, the proposal’s details suggest this is more a wish than a promise.  There is no stated obligation on the new guarantors to cross subsidize borrowers or expand credit access.  This likely would exacerbate current wide disparities in how communities of color are treated by the mortgage system by codifying into law constraints that would disproportionately affect them.

Loans eligible for the new securities guarantee would have to have at least 5 percent down.  The summary would require further private credit insurance for loans between 85 and 95 percent LTV, an unexplained change from the long-standing requirement for loans with LTVs above 80 percent. It would require “bank like” capital levels for the “Private Credit Enhancers” for the full outstanding balance of insured debt standing in front of the Ginnie securities guarantee, and require them to use credit risk transfer techniques to further de-risk their books.  

Lastly, the summary would require loans backing the securities to meet the “regulatory and statutory” standards of a Qualified Mortgage (QM) – which under present regulations would limit maximum debt to income ratios to 43 percent.

These constraints – maximum 95 percent LTV, bank like capital requirements on credit enhancers, and application of the QM standards without allowing for compensating credit quality factors – make it likely that only the most qualified borrowers would be served by the proposed system.  Many low wealth, moderate income families almost certainly could not meet the qualifying standards, and many of those who could would find the amounts charged by private enhancers using bank like capital excessive and poor competition for FHA, VA or other direct government credit enhancements.  

This would be a significant difference between today’s regime where Fannie and Freddie must meet regulatory housing goals to assure at least a minimal level of service to LMI borrowers and communities and offer to finance loans with down payments as low as 3 percent, and one where there were no such requirements.

In lieu of today’s access regime, which features the housing goals, affirmative obligations to broadly serve credit markets and specific “duty to serve” requirements, the draft would impose a fee on mortgages backing the new securities to finance directly programs like the Housing Trust Fund, Capital Magnet Fund and other appropriated programs.  This is similar to fees proposed as part of most reform proposals, including the ill-fated Corker-Warner reboot released in 2018, whose shortcomings I analyzed here.  It is an important concession.  But it is no substitute for a comprehensive commitment to broad credit access through a new federal guarantee.

Both Mssrs. Hensarling and Delaney are retiring from Congress at the end of 2018.  There is no chance this summary will result in legislation that moves in the Congress any time soon.  The draft represents a welcome end to Mr. Hensarling’s stubborn opposition to a government guarantee in the conventional market.  But it needs much work to meet even a threshold standard for attention to the needs of LMI and minority aspiring homebuyers.

Trump GSE reform plan -- more guarantors, no affordable housing requirements

June 25, 2018

Tucked inside the 135-page Delivering Government Solutions in the 21st Century:  Reform Plan and Reorganization Recommendations released by the Trump Administration on June 21, 2018 are three pages of recommendations for reforming the mortgage finance system.  The good news is that they support a federal role in supporting US mortgage markets through a full guarantee of qualified mortgage backed securities, access to this guarantee by primary market lenders of all types and sizes, and an explicit fee on outstanding securities to fund badly needed support for low income rental housing.  The bad news is it would set up a system of private guarantors with no apparent obligation to fully serve or support LMI borrowers and communities, leaving this responsibility entirely to the federal government through the mortgage programs at FHA, Rural Housing Services and the VA.

This plan follows the general outlines of successive proposals that have been presented since 2008, including the Bipartisan Policy Center's Housing Commission recommendations, the 2014 Corker-Warner and Johnson-Crapo legislative drafts, the more recent 2018 Corker-Warner efforts and even the Obama Administration in one of its options in its 2011 housing finance reform paper.  

Fannie and Freddie would lose their congressional charters.  The US Government would issue guarantees on securities issued by fully privatized Fannie and Freddie, as well as other guarantors approved by a federal regulator.  Taxpayers and government insurance "...would be protected by virtue of the capital requirements imposed on the guarantors, maintenance of responsible loan underwriting standards, and other protections deemed appropriate..." by their regulator. 

The plan would not require these new private guarantors to shoulder any responsibilities for assuring mortgage access for low and moderate income borrowers and communities.  Instead, the plan would shift that responsibility entirely to FHA, Rural Housing Services (RHS) and the Veterans' Administration (VA).  As stated in the proposal, "the newly fully-privatized GSEs would have mandates focused on defining the appropriate lending markets served in order to level the playing field with the private sector and avoid unnecessary cross-subsidization.  A separate fee on the outstanding volume of the MBS issued by guarantors would be used specifically for affordable housing purposes, and would be transferred through congressional appropriations to, and administered by, HUD." (emphasis added).

There is a long-standing expectation that private entities that enjoy the federal government's support for their businesses have a reciprocal duty to ensure those benefits are shared as widely and equitably as possible.  Thus Fannie and Freddie have housing goals to gauge their success at serving LMI borrowers and communities, a fee to support affordable housing and community development, and a duty to serve specific underserved markets.  Regulated, insured primary market lenders have Community Reinvestment Act (CRA) obligations to ensure they serve the full needs of the communities they are chartered to serve.

This draft appears to break that tradition.  

I have advocated for a more inclusive approach to the federal government's support for homeownership and mortgage finance before.  FHA and its sister federal mortgage actors need to be seen as part of the broad federal solution set, operating together with private capital to assure the broadest possible service. But private entities enjoying the government's support must be held to an expectation they will serve the market as fully as possible, not just to maximize their returns and shift the entire burden of serving low wealth borrowers with less than perfect credit to federal insurance programs.  

There is little chance the Administration's proposal will lead to any legislative action this year.  But its decision to wade into the mortgage reform pool at last is significant, even if buried in their reorganization plan and released with little fanfare.  Its apparent decision to divorce issues of access and affordability from the new guarantors it hopes will compete with newly privatized Fannie and Freddie is disappointing.