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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.


Senate Draft's Cross Subsidy Approach Misses the Mark

March 01, 2018

A wholesale reconstruction of the country’s mortgage finance system is a rare opportunity to take all of the federal government’s direct and indirect supports for home finance and use them to create a sensible system that protects taxpayers, assures full access to credit, and supports liquidity for the long term, fixed rate mortgages that consumers prefer.  But the draft GSE reform bill that was widely circulated in late January instead perpetuates the current separation of the so-called “conventional” market from the government market supported by FHA, VA and RHS.  The draft could use the government’s various existing forms of mortgage credit insurance as a conscious part of a new secondary market model in order to assure a broad and responsible spectrum of credit risk at the most affordable cost to consumers.  Instead, the system would divert the proceeds of a 10 basis point fee on guaranteed securities from supporting rental housing and community development efforts for very low income households to a new form of cross subsidy that effectively will subsidize private Mis and the new guarantors.

Even with the draft’s proposed subsidy, the draft will leave a significant portion of the market to FHA.  Borrowers with very little cash to put down and moderate credit scores will still find FHA their most economical choice.  The subsidy will pull some share of borrowers into the private system, but it will not do so for them all.  Even with its problems, FHA will remain a major part of the federal system of support for home ownership finance.  The draft’s failure to incorporate it more intentionally into its proposed new structure is a missed opportunity.

There are other concerns with the draft, including the lack of enforceable standards of service to under served communities and borrowers for the new guarantors.  Subsequent versions may change its outlines significantly.  But Congress faces what will hopefully be a once in a generation opportunity to redefine federal support for mortgage finance.  Its goal should be a durable, comprehensive system.  Trying to solve broad challenges of access in the market by isolating a new privately funded system from the government’s other supports will only perpetuate the uncoordinated and unsatisfactory system we have today.  We can and should do better than that.

Private Guarantors and Risk Based Pricing

The draft would rely on newly chartered private guarantors operating with market-priced capital.  It also would require these guarantors to off load much of the credit risk to others, like MIs. In turn, this would drive risk-based fees for their credit insurance and that of their risk sharing partners.  Borrowers with higher risk profiles – typically those with lower down payments and lower credit scores – would be charged progressively higher fees.   The bill would use the 10-basis point fee to offset these risk-based costs for certain borrowers. The draft defines these as borrowers with incomes below 80 percent AMI (or first-time homebuyers below 100 percent AMI).  A recent Urban Institute analysis suggests that this could range from between $929 and $236 in yearly mortgage cost savings, depending on a family’s income.   This effectively would shift the fee’s proceeds from supporting affordable rental housing for families at or below 30 percent of AMI, and community development efforts that support LMI communities, to helping some unknown number of aspiring homebuyers with a modest subsidy.

Such a subsidy might be justified if many consumers would be denied mortgage credit without it, or a ready means to provide lower cost insurance to the same borrowers was not readily available.  But, in reality, FHA is and will remain consumers’ alternative when it can offer a better “sticker price” than privately capitalized credit insurance.  (The same is true of insurance programs offered by the VA and USDA’s Rural Housing Services, but FHA will be the likely alternative for most consumers.)

An expansive and inclusive approach that consciously incorporates existing mission driven government supported mortgage credit insurance alongside that offered by the privately capitalized guarantors and their risk sharing partners like MIs would assure a broad range of credit pricing and availability through the proposed new securitization platform without needing to use the proposed new fee to subsidize market-priced risk.  This might even spur competition from these private insurers, which could expand private capital’s role in serving more borrowers without requiring the proposed subsidy. It also could help strengthen FHA's book by adding borrowers with relatively stronger credit and countering some of the adverse selection it otherwise will suffer.

Instead, the draft would use most of the 10-bps fee to reduce the impact of market driven pricing for some borrowers, and enable Mis and the guarantors to employ full risk based pricing without losing some borrowers to a cheaper FHA execution.  Relying on FHA to provide this cross subsidy in the overall system also would reduce the impact of market pricing without needing to divert the fee.

The 10-basis point fee’s original purpose was to generate a dependable source of funding for desperately needed affordable rental housing production and preservation, and support for community development investments, along with a modest set aside for supporting market expanding activities through a newly structured mortgage finance system.  It was meant to replace a far more modest annual assessment under the 2008 HERA legislation governing Fannie Mae and Freddie Mac, which has generated several hundred million dollars in support for the Housing Trust Fund and Capital Magnet Fund in each of the last few years.  This would still be the highest and best use of the fee.  Diverting it might move the proposed system’s reach a little further in FHA’s direction.  But it would not actually add any new mortgage borrowers to the federal government’s overall coverage.  Drafters could restore some of this funding by increasing the fee.  But this would only add more cost for all consumers in the system while bypassing FHA’s ability to support a cross subsidy for higher risk borrowers.

Alternative Approaches

There are multiple ways the bill’s higher market-driven costs to consumers could be mitigated.  The Mortgage Bankers Association 2017 proposal for multiple private guarantors, which is a partial blueprint for the draft, included utility-like regulation of new guarantors’ returns, controlling  their costs and potentially enabling lower overall charges to consumers.  Private mortgage insurers and guarantors could be regulated to use less loan level risk-based pricing and more broad pool pricing of risk. The new guarantors could be required to accept lower returns for loans serving a defined group of borrowers, as Fannie and Freddie are required today, forcing the cross subsidy to be borne by the guarantors benefitting from the securities guarantee. The drafters could reduce the amount of insurance in front of the government and use the government securities guarantee, which would not rely on loan level risk-based pricing, to cover more of the risk.  They could encourage the development of risk sharing pilots combining FHA and private mortgage insurance as has been suggested by others for years.  It also could include participation by other mission-driven market participants such as state housing finance agencies, Federal Home Loan Banks, and CDFIs like Self Help Venture Fund, which already operates a competitive and successful credit enhancement program with Freddie Mac, to diversify credit insurance offerings and deliver more value to consumers. 

Even if the entire 10 bps in the Senate draft, estimated to be an annual flow of about $5 billion once the new system is up and running, is diverted to cross-subsidizing the private credit insurers, there will still be borrowers for whom the price of a loan under the new system is higher than the price of a loan with FHA insurance.  Indeed, a recent Urban Institute analysis concludes that the draft’s proposed use of the fee is unlikely to reduce FHA’s market share from what it has today.  But it will cost billions in explicit subsidies to produce this result.  Relying more on FHA would expand its market share. But it would help create a broader range of credit pricing across the system, and probably strengthen rather than weaken FHA's own insurance book.  

Government programs like FHA and VA offer alternate, less costly mortgage insurance featuring broad risk pooling and attendant average risk pricing.  They charge lower rates for weaker credit borrowers than privately capitalized insurers will offer because of their explicit government sponsorship and support, and their mission-based approach.  They have a track record over more than 80 years.  The sensible course would be to exploit this valuable resource and rely upon it as an affordable alternative form of primary credit insurance alongside the draft’s totally free market pricing model.  Integrating these approaches would produce a broad policy approach to mortgage credit access that would mix public and private support to reach the best solution for taxpayers and borrowers.  In contrast, the net effect of the proposed cross subsidy in the Senate draft really will be to use the 10-basis point fee to shift market share from affordable government-supported insurance that is already available at a competitive price to private insurance. 

The draft also would give FHFA or its successor new responsibilities to design, execute and monitor other more direct forms of subsidy contemplated in the draft, such as down payment assistance, or consumer counseling support.  But HUD, the VA and the Department of Agriculture’s Rural Development Administration, and state and local governments, already have the capacity and expertise to do this.  If this is such an important outcome, the Housing Trust Fund’s purposes could be enlarged to include specific attention it.  Why add these tasks to yet another federal department that should be laser-focused on the government’s total exposure to mortgage credit risk and the larger mortgage finance system’s stability and liquidity?

FHA Also Has Issues

New legislation need not tackle the myriad administrative problems plaguing FHA for the FHA (as well as VA and RHS) to continue to play a principal role in making mortgage credit affordable.  But there is no doubt that much should be done to tackle FHA’s outdated technology, inadequate quality control and counterparty risk management.  Lenders remain wary of FHA’s reliability.  The loan level certifications lenders must sign, and the risk of False Claim Act prosecutions for errors in loan manufacturing are handicapping FHA’s market role.  HUD’s leadership, lenders, consumer advocates and congressional leaders are pushing for sensible reforms to FHA and they need to continue to do so.

But FHA in the meantime will continue to play a major role in the mortgage finance system.  Not including its ability to offer lower cost mortgage insurance that is average priced and provides access to lower wealth borrowers and those with weaker credit wastes a valuable resource and perpetuates a separation among the government's various direct and indirect supports for mortgage credit.  

The leaked draft's design may not move forward.  I joined with other co-authors to recommend a different approach that did incorporate FHA more fully. But any system that relies on private capital to absorb losses ahead of a government securities guarantee will have to confront the challenge of how to insure broad access for responsible borrowers in the face of private sector return expectations.  Failing to take advantage of FHA in a comprehensive system would miss an important chance to use an existing tool and to more closely integrate the government's approaches to supporting mortgage finance.


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