Tag Archives: reform

Framing Bipartisan Housing Finance Reform

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photo by Jan Tik

The Bipartisan Policy Center has issued A Framework for Improving Access and Affordability in a Reformed Housing Finance System. The brief was written by Michael Stegman who had served as the Obama Administration’s top advisor on housing policy. It opens,

With policymakers gearing up to reform the housing finance system, it is worth revisiting one of the issues that stymied negotiators in the reform effort of 2014: how to ensure adequate access to credit in the new system. The political landscape has changed substantially since 2014. For those who are focused on financing affordable housing and promoting access to mortgage credit, the status quo—the continued conservatorship of Fannie Mae and Freddie Mac—may no longer be as appealing as it was during those negotiations. This brief draws upon the lessons learned from that experience to outline a framework for bipartisan consensus in this transformed political environment.

The “middle-way” approach described here is not dependent upon any one structure or future role for the government-sponsored enterprises (GSEs), though it does assume the continuation of a government guarantee of qualified mortgage-backed securities (MBS). It is this guarantee that forms the basis of the obligation to ensure that the benefits flowing from the government backstop are as broadly available as possible, consistent with safety and soundness and taxpayer protection.

In recent months, at least three such proposals have been developed that preserve a federal backstop (see Mortgage Bankers Association, Bright and DeMarco, and Parrott et al. proposals). Should the administration and Congress pursue a strict privatization approach to reform, lacking a guarantee, it’s unlikely that any affordable housing obligations would be imposed in the reformed system. (cover page, footnotes omitted)

Stegman goes on to describe “The Affordable Housing Triad:”

Over the years, Congress has made it clear that the GSEs’ public purpose includes supporting the financing of affordable housing and promoting access to mortgage credit “throughout the nation, including central cities, rural areas, and underserved areas,” even if doing so involves earning “a reasonable economic return that may be less than the return earned on other activities.” As part of this mandate, policymakers have created a triad of affordable housing and credit access requirements:

  1. Meeting annual affordable-mortgage purchase goals set by the regulator;
  2. Paying an assessment on each dollar of new business to help capitalize two different affordable housing funds; and
  3. Developing and executing targeted duty-to-serve strategies, the purpose of which is to increase liquidity in market segments underserved by primary lenders and the GSEs, defined by both geography and housing types. (1, footnote omitted)

The paper outlines three bipartisan options that would not

compromise the obligation to provide liquidity to all corners of the market at the least possible cost, consistent with taxpayer protection and safety and soundness. Each option attempts to ensure that the system as a whole provides access and affordability at least as much as the existing system; includes an explicit and transparent fee on the outstanding balance of guaranteed MBS; and includes a duty to serve the broadest possible market. (3)

The paper is intended to spark further conversation about housing finance reform while advocating for the needs of low- and moderate-income households. I hope it succeeds in pushing Congress to focus on the details of what could be a bipartisan exit strategy from the endless GSE conservatorships.

 

American Bankers on Mortgage Market Reform

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The American Bankers Association has issued a white paper, Mortgage Lending Rules: Sensible Reforms for Banks and Consumers. The white paper contains a lot of common sense suggestions but its lack of sensitivity to consumer concerns greatly undercuts its value. It opens,

The Core Principles for Regulating the United States Financial System, enumerated in Executive Order 13772, include the following that are particularly relevant to an evaluation of current U.S. rules and regulatory practices affecting residential mortgage finance:

(a) empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth;

(c) foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry; and

(f) make regulation efficient, effective, and appropriately tailored.

The American Bankers Association offers these views to the Secretary of the Treasury in relation to the Directive that he has received under Section 2 of the Executive Order.

 Recent regulatory activity in mortgage lending has severely affected real estate finance. The existing regulatory regime is voluminous, extremely technical, and needlessly prescriptive. The current regulatory regimen is restricting choice, eliminating financial options, and forcing a standardization of products such that community banks are no longer able to meet their communities’ needs.

 ABA recommends a broad review of mortgage rules to refine and simplify their application. This white paper advances a series of specific areas that require immediate modifications to incentivize an expansion of safe lending activities: (i) streamline and clarify disclosure timing and methodologies, (ii) add flexibility to underwriting mandates, and (iii) fix the servicing rules.

 ABA advises that focused attention be devoted to clarifying the liability provisions in mortgage regulations to eliminate uncertainties that endanger participation and innovation in the real estate finance sector. (1, footnote omitted)

Its useful suggestions include streamlining regulations to reduce unnecessary regulatory burdens; clarifying legal liabilities that lenders face so that they can act more freely without triggering outsized criminal and civil liability in the ordinary course of business; and creating more safe harbors for products that are not prone to abuse.

But the white paper is written as if the subprime boom and bust of the early 2000s never happened. It pays not much more than lip service to consumer protection regulation, but it seeks to roll it back significantly:

ABA is fully supportive of well-regulated markets where well-crafted rules are effective in protecting consumers against abuse. Banks support clear disclosures and processes to assure that consumers receive clear and comprehensive information that enables them to understand the transaction and make the best decision for their families. ABA does not, therefore, advocate for a wholesale deconstruction of existing consumer protection regulations . . . (4)

If we learned anything from the subprime crisis it is that disclosure is not enough.  That is why the rules.  Could these rules be tweaked? Sure.  Should they be dramatically weakened? No. Until the ABA grapples with the real harm done to consumers during the subprime era, their position on mortgage market reform should be taken as a special interest position paper, not a white paper in the public interest.

Budding GSE Reform

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The Mortgage Bankers Association has released a paper on GSE Reform: Creating a Sustainable, More Vibrant Secondary Mortgage Market (link to paper on this page). This paper builds on a shorter version that the MBA released a few months ago. Jim Parrott of the Urban Institute has provided a helpful comparison of the basic MBA proposal to two other leading proposals. This longer paper explains in detail

MBA’s recommended approach to GSE reform, the last piece of unfinished business from the 2008 financial crisis. It outlines the key principles and guardrails that should guide the reform effort and provides a detailed picture of a new secondary-market end state. It also attempts to shed light on two critical areas that have tested past reform efforts — the appropriate transition to the post-GSE system and the role of the secondary market in advancing an affordable-housing strategy. GSE reform holds the potential to help stabilize the housing market for decades to come. The time to take action is now. (1)

Basically, the MBA proposes that Fannie and Freddie be rechartered into two of a number of competitors that would guarantee mortgage-backed securities (MBS).  All of these guarantors would be specialized mortgage companies that are to be treated as regulated utilities owned by private shareholders. These guarantors would issue standardized MBS through the Common Securitization Platform that is currently being designed by Fannie and Freddie pursuant to the Federal Housing Finance Agency’s instructions.

These MBS would be backed by the full faith and credit of the the federal government as well as by a federal mortgage insurance fund (MIF), which would be similar to the Federal Housing Administration’s MMI fund. This MIF would cover catastrophic losses. Like the FHA’s MMI fund, the MIF could be restored by means of higher premiums after the catastrophe had been dealt with.  This model would protect taxpayers from having to bail out the guarantors, as they did with Fannie and Freddie at the onset of the most recent financial crisis.

The MBA proposal is well thought out and should be taken very seriously by Congress and the Administration. That is not to say that it is the obvious best choice among the three that Parrott reviewed. But it clearly addresses the issues of concern to the broad middle of decision-makers and housing policy analysts.

Not everyone is in that broad middle of course. But there is a lot for the Warren wing of the Democratic party to like about this proposal as it includes affordable housing goals and subsidies. The Hensarling wing of the Republican party, on the other hand, is not likely to embrace this proposal because it still contemplates a significant role for the federal government in housing finance. We’ll see if a plan of this type can move forward without the support of the Chair of the House Financial Services Committee.

The Money Problem

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Professor Ricks

I recently read The Money Problem: Rethinking Financial Regulation by Morgan Ricks (University of Chicago Press 2016).  While it is not a book for the financially faint of heart, it does provide a great introduction to what money is and what banks and other financial intermediaries do. The back matter reads,

Years have passed since the world experienced one of the worst financial crises in history, and while countless experts have analyzed it, many central questions remain unanswered. Should money creation be considered a ‘public’ or ‘private’ activity—or both? What do we mean by, and want from, financial stability? What role should regulation play? How would we design our monetary institutions if we could start from scratch?

In The Money Problem, Morgan Ricks addresses all of these questions and more, offering a practical yet elegant blueprint for a modernized system of money and banking—one that, crucially, can be accomplished through incremental changes to the United States’ current system. He brings a critical, missing dimension to the ongoing debates over financial stability policy, arguing that the issue is primarily one of monetary system design. The Money Problem offers a way to mitigate the risk of catastrophic panic in the future, and it will expand the financial reform conversation in the United States and abroad.

I particularly recommend Part I to those trying to get their hands around money (the concept, not hard currency itself) and how it is created. Ricks reviews the “standard textbook description” of bank money creation and others’ account of it before providing his own “modified story.” (58-59)

Parts II and III provides a far-reaching blueprint for reforming the monetary system.  This reform agenda is not without its critics, but I think Ricks gives a fair reading to competing views so you can make up your own mind as to who is right.

Can Fannie and Freddie Be Privatized?

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Kroll Bond Rating Agency posted Housing Reform 2017: Can the GSEs be Privatized? The big housing finance reform question is whether there is now sufficient consensus in Washington to determine the fate of Fannie and Freddie, now approaching their ninth year in conservatorship.

Kroll concludes,

The Mortgage Bankers Association sends a very clear message about privatizing the GSEs: It will raise rates for homeowners and add systemic risk back into the financial system. Why do we need to fix a proven market mechanism that is not broken? KBRA believes that if Mr. Mnuchin and the President-elect truly want to encourage the growth of a private market for U.S. mortgages, then they must accept that true privatization of the GSEs that eliminates any government guarantee would fundamentally change the mortgage market.

The privatization of the GSEs implies, in the short term at least, a significant decrease in the financing available to the U.S. housing market. In the absence of a TBA market, no coupon would be high enough to support the entire range of demand for mortgage finance, only pockets of higher quality loans as with the jumbo mortgage market today. Unless the U.S. moved to the Danish model with 100% variable rate notes, no nonbank could fund the production of home mortgages efficiently and commercial banks are unlikely to pick up the slack for the reasons discussed above.

In the event of full privatization of the GSEs, private loans will have significantly higher cost for consumers and offer equally more attractive returns for financial institutions and end investors, a result that would generate enormous political opposition among the numerous constituencies in the housing market. Needless to say, getting such a proposal through Congress should prove to be quite an achievement indeed. (4)

I disagree with Kroll’s framing of the issue:  “Why do we need to fix a proven market mechanism that is not broken?” To describe Fannie and Freddie as “not broken” seems farcical to me. They are in a state of limbo with extraordinary backing from the federal government. It might be that we would want to continue them with much the same functionality that they currently have, but we would still want this transition to be done intentionally.  Nobody, but nobody, was thinking that putting them into conservatorship was the end game,

While the current structure has some advantages over privatization, the reverse is true too.  The greatest benefit of privatization is getting rid of the taxpayer backstop in case of a failure by one or both of the companies.

We shouldn’t be saying — hey, what we have now is good enough. Rather, we should be asking — what do we expect out of our housing finance system and how do we get it?

There appears to be a broad consensus to reduce taxpayer exposure to a bailout.  There also appears to be a broad consensus (one that I do not support as broadly as others) to protect the 30 year fixed rate mortgage that remains so popular in the United States.

Industry insiders believe that a fully private system would not provide sufficient capital for the mortgage market. They are also concerned that a fully private system would put the kibosh on the To Be Announced (TBA) market that provides so much stability for the mortgage origination process.

A thoughtful reform proposal could incorporate all of these concerns while also clearing away the sticky problems built into the Fannie/Freddie model of housing finance.

“If it ain’t broke don’t fix it” is not a good enough philosophy after we have lived through the financial crisis. We should focus on the big questions of what we want from our 21st century housing finance system and then design a system that will implement it accordingly.

Will Congress Recap and Release Fannie & Freddie?

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Senator Shelby

Senator Shelby

Richard Shelby, the Chair of the Senate Committee on Banking, Housing, and Urban Affairs asked the Congressional Budget Office to prepare a report on The Effects of Increasing Fannie Mae’s and Freddie Mac’s Capital. The report acknowledges that the legislative reform of the two companies is going nowhere, but it analyzed one potential reform option that shares characteristics with some of the GSE reform bills that have been introduced over the years. The option studied by the CBO contemplates recapitalizing the two companies along the following lines:

each GSE would be allowed to retain an average of $5 billion of its profits annually and would thus increase its capital by up to $50 billion over 10 years. The government’s commitment to purchase more senior preferred stock from Fannie Mae and Freddie Mac if necessary to ensure that they maintain a positive net worth would remain in place. In addition, the GSEs would invest the profits that they retained under the option in Treasury securities, and returns on those securities would raise the GSEs’ income. Through its holdings of senior preferred stock, the government would continue to have a claim to the GSEs’ net worth ahead of other stockholders. (2, footnote omitted)

The CBO’s mandate is “to provide objective, impartial analysis,” but this report seems like it is laying the groundwork for a proposal to recapitalize Fannie and Freddie so that they can be released from conservatorship. Most policy analysts (as opposed to investors in the two companies) think that allowing the two companies to return to their prior lives as public/private hybrids is a terrible idea. It is too difficult for them to simultaneously answer to the federal regulators who set their public mission as well as to the private shareholders who would ultimately own them. And, if we were to take this path, the taxpayer would be left holding the bag once again if they were to ever need another bailout.

I think that Senator Shelby has done GSE reform a disservice by looking at this recapitalization option out of context. What we need is an analysis of a compromise plan that Congress can pass once the election is settled. Otherwise we are just leaving the two companies to limp along in conservatorship, slouching toward their next, yet unknown, crisis. Or worse, we are preparing to release them from conservatorship to go back to business as usual. Both of those options are very bad. Congress owes it to the American people to create a workable housing finance system for the 21st century that does not repeat our past mistakes.

Obama Administration on Frannie

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Michael Stegman

Michael Stegman, a White House Senior Policy Advisor, offered up the Obama Administration’s “perspective on critical housing issues” recently. (1) I found the remarks on the future of Fannie and Freddie to be of particular interest:

Before discussing what we would like to see happen in this Congress on GSE reform, you should be aware that last week the Administration made clear its opposition to taking any action in support of what has become known as “recap and release.” We believe that recapitalizing the GSEs with taxpayer funds and administratively- or legislatively-releasing them from conservatorship with a business model that conflicts with their public mission— in essence turning back the clock to the run up to the crisis~ would be both bad policy and poor stewardship of the taxpayers’ interest; willfully recreating the very system that helped do this nation so much harm.
ln remarks I presented two weeks ago at the Mortgage Bankers Association conference, I cautioned that no one should be misled by the increasingly noisy chorus of the advocates of recap and release, many of whom have placed big bets against reform so they can make a‘profit, and are doing everything they can to make sure that those bets pay off.
Nor, I said, should their promise that recap and release would generate a pot of money for affordable housing be taken seriously.
Despite claims to the contrary, recapitalizing the GSEs would not itself provide any resources for affordable housing. Nor can a related — or even unrelated — sale of Treasury’s investment in the GSEs provide any resources for affordable housing. The proceeds of the sale of any GSE obligations acquired by Treasury must by law be “dedicated for the sole purpose of deficit reduction.”
Rather than freeing recapitalized GSEs from conservatorship with their flawed charters intact, we should pursue more comprehensive approaches to reform such as those that members of Congress have introduced over the past two years including mutualizing Fannie and Freddie, or build upon bipartisan agreements on the features of a future secondary market system that were hammered out in the Senate Banking Committee last year:
Preservation of the TBA market; an explicit, paid for government guarantee of catastrophic losses for investors in qualifying MBS; maintaining a clear separation of the primary and secondary markets; ensuring the flow of mortgage credit in both good times and bad; separating the securitization plumbing from private credit risk taking; ensuring that community lenders have the same access to the secondary market as big banks; and making the benefits of government guaranteed MBS available to all households — both those who choose to rent and those with the ability and desire to own.
Members in Congress also reached bipartisan consensus on a transparent way to serve those the private market cannot serve without subsidy, through an annual 10 basis point assessment on the outstanding balance of government-guaranteed MES—which once fully implemented, would generate about 15 times more resources a year for affordable housing than FHFA is expected to raise through the GSEs’ current affordable housing levy–though we were pleased to see the Director begin collections on the affordability fee and look forward to effectively implementing the dollars through the Housing Trust Fund and the Capital Magnet Fund that should become available for the first time in the early months of 2016.
But there is much more work to be done on ensuring a level playing field in the new system, including a robust role for community banks and credit unions who know how best to serve their customers, and ensuring that all communities are served fairly, which can be most effectively achieved through a statutory duty to serve. Regrettably, the Committee could not agree upon such a provision during last year’s negotiations, and we will continue to fight for it. (3-4)
Much of these remarks are eminently reasonable but I have to say that the Obama Administration has not deployed much political capital on reforming the housing finance system. This has left the whole system in limbo and the longer it stays in limbo, the more likely it is that special interests will make inroads into the reform of the system, inroads that will not be in the public interest.
While the likelihood of reform coming out of the current Congress is incredibly small, the Administration should take all of the administrative steps it can to sketch out an outline of a housing finance system that can work for a broad range of borrowers through the credit cycle without putting excessive risk on taxpayers.
The Administration has taken some steps in the right direction, like off-loadling some risk from Fannie and Freddie to private investors. But there is a lot more work to be done if we are to have a system that provides the optimal amount of credit through the 21st century.