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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.

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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.

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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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Mortgage Finance Reform Panel Dicsussion, CFA Financial Services Conference

December 02, 2017

CFA's 2017 Financial Services Conference featured a panel discussion on Dec 1 with Michael Stegman, Milken Institute; Mark Zandi, Moody's Analytics; Steve O'Connor, Mortgage Bankers Association; and Robert Henson, Credit Union National Association.

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Credit Access and Mortgage Finance Reform

May 08, 2017

In late April, 2017 I was invited to participate in a panel on affordability issues in mortgage finance reform at a New York workshop sponsored by the Federal Reserve Banks of New York and Atlanta, the Federal Reserve Board, the Wharton School at University of Pennsylvania, and UCLA's Anderson School of Management. I summarized what I think are the critical pillars of a mortgage finance system, which I’ve edited into the bullets below.  Four colleagues and I expanded on the need for and an approach to affordability in mortgage finance reform in January as part of our series of essays describing A More Promising Road to GSE Reform, which can be downloaded through the link.

Assure that entities that use government support do not “cream” the market

This first point seems obvious and hard to oppose – a mortgage finance regime supported by the government should not be allowed to exclude credit worthy borrowers or reduce liquidity for primary market lenders serving these communities without good cause.  At a minimum, the book of business at these entities should reflect the distribution of loans being originated across income, race and other characteristics.  This is the central, original purpose of the housing goals.  Yes, they are imperfect and sometimes have been misused.  But you cannot assess what you cannot measure.  Some form of bench-marking, whether imposed by the government regulator based on market research and projection, or by the entities themselves using market data and economic projections approved by a regulator as some have suggested, is needed to monitor guarantors’ performance.  Fannie and Freddie have been under a revised housing goals regime since coming under conservatorship in 2008 and the HERA revisions and a de-politicized goals process have improved them.  In fact, GSE credit terms are significantly tighter than in the early 2000's under this regime, a continuing issue that still needs to be addressed.

Create a mandate for “leading the market” into new areas through research, pilots, and partnerships that extend secondary market liquidity responsibly

But matching the market is not enough.  The government’s support for these entities should include an obligation to use the secondary market’s central role in the marketplace to responsibly expand credit.  This is what the often-abused term “lead the market” means to me.  This “duty to serve” requirement was adopted in the 2008 HERA GSE amendments to focus attention on three specific market sectors – rural housing, manufactured housing and affordable housing preservation. Fannie and Freddie published their first proposed DTS plans under this provision on May 8.  What was speculative in 2013 has become an operating reality.  It should not be cast aside as reform discussions move forward.

Charge a fee on government backed MBS to support market expanding activities and contribute to support for low income rental assistance programs

Finally, reform should include a fee on all government backed MBS in the form of a strip collected every year on outstanding securities.  These proceeds should fund the market expanding efforts in the duty to serve, through risk sharing on new, untested products, on helping to create additional effective demand from consumers, and so on, as well as housing and community development funding outside of the mortgage finance system.  Fannie and Freddie's DTS plans should show further examples of how the GSEs can help develop and prove new markets. The GSEs today already pay an assessment on each year’s business to fund the Housing Trust Fund and Capital Magnet Fund, this year amounting to $455 million.  Shifting this volume-based one-time fee to a yearly ongoing strip will provide a significantly larger and more reliable source to continue that funding in addition to the market expanding efforts in the duty to serve. 

The Promising Road proposal I co-authored and the MBA’s new effort both envision some form of this combination of requirements in a future system.  The recent Milken Institute proposal includes the fee in the form of a 10 basis point strip -- as did the ill-fated Johnson-Crapo legislation in 2014 --  and suggests further elaboration in a later paper. These features are already required under conservatorship.  Reform should maintain and improve them.  Without these or similar requirements that blend quantitative measures of broad service to the market, an expectation that enterprises benefiting from a federal guarantee will help lead the market into new opportunities, and funding to support such work through a fee, reform could easily wind up sponsoring mortgage credit in ways that exclude households and communities from its benefits, an unacceptable outcome.

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