Bringing Housing Finance Reform over the Finish Line

photo by LarryWeisenberg

Mike Milkin at Milkin Institute Global Conference

The Milkin Institute have released Bringing Housing Finance Reform over the Finish Line. It opens,

The housing finance reform debate has once again gained momentum with the goal of those involved to move forward with bipartisan legislation in 2018 that results in a safe, sound, and enduring housing finance system.

While there is no shortage of content on the topic, two different conceptual approaches to reforming the secondary mortgage market structure are motivating legislative discussions. The first is a model in which multiple guarantor firms purchase mortgages from originators and aggregators and then bundle them into mortgage-backed securities (MBS) backed by a secondary federal guarantee that pays out only after private capital arranged by each guarantor takes considerable losses (the multiple-guarantor model). This approach incorporates several elements from the 2014 Johnson-Crapo Bill and a subsequent plan developed by the Mortgage Bankers Association. Fannie Mae and Freddie Mac—the government-sponsored enterprises (GSEs)—would continue as guarantors, but would face new competition and would no longer enjoy a government guarantee of their corporate debt or other government privileges and protections.

The second housing finance reform plan is based on a multiple-issuer, insurance-based model originally proposed by Ed DeMarco and Michael Bright at the Milken Institute, and builds on the existing Ginnie Mae system (the DeMarco/Bright model). In this model, Ginnie Mae would provide a full faith and credit wrap on MBS issued by approved issuers and backed by loan pools that are credit-enhanced either by (i) a government program such as the Federal Housing Administration (FHA) or U.S. Department of Veterans Affairs (VA), or (ii) Federal Housing Finance Agency (FHFA)- approved private credit enhancers that arrange for the required amounts of private capital to take on housing credit risk ahead of the government guarantee. Fannie Mae and Freddie Mac would be passed through receivership and reconstituted as credit enhancement entities mutually owned by their seller/servicers.

While the multiple guarantor and DeMarco/Bright models differ in many ways, they share important common features; both address key elements of housing finance reform that any effective legislation must embrace. In the remainder of this paper, we first identify these key reform elements. We then assess some common features of the two models that satisfy or advance these elements. The final section delves more deeply into the operational challenges of translating into legislative language specific reform elements that are shared by or unique to one of the two models. Getting housing finance reform right requires staying true to high-level critical reform elements while ensuring that technical legislative requirements make economic and operational sense.  (2-3, footnotes omitted)

The report does a good job of outlining areas of broad (not universal, just broad) agreement on housing finance reform, including

  • The private sector must be the primary source of mortgage credit and bear the primary burden for credit losses.
  • There must be an explicit federal backstop after private capital.
  • Credit must remain available in times of market stress.
  • Private firms benefiting from access to a government backstop must be subject to strong oversight. (4-5)

We are still far from having a legislative fix to the housing finance system, but it is helpful to have reports like this to focus us on where there is broad agreement so that legislators can tackle the areas where the differences remain.

Framing Bipartisan Housing Finance Reform

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.

 

Fannie/Freddie Scorecard

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The Federal Housing Finance Agency released its 2017 Scorecard for Fannie Mae, Freddie Mac, and Common Securitization Solutions.  The scorecard highlights how the FHFA’s reform of Fannie Mae and Freddie Mac is proceeding apace, absent direction from Congress.  This reform path had been set by Acting Director DeMarco, appointed by President Bush, and has continued relatively unchanged under Director Watt, appointed by President Obama.

The scorecard’s assessment criteria for the two companies are,

  • The extent to which each Enterprise conducts initiatives in a safe and sound manner consistent with FHFA’s expectations for all activities;
  • The extent to which the outcomes of their activities support a competitive and resilient secondary mortgage market to support homeowners and renters;
  • The extent to which each Enterprise conducts initiatives with consideration for diversity and inclusion consistent with FHFA’s expectations for all activities;
  • Cooperation and collaboration with FHFA, each other, the industry, and other stakeholders; and
  • The quality, thoroughness, creativity, effectiveness, and timeliness of their work products. (2)

The scorecard states that Fannie and Freddie should increase credit risk transfers to investors.  Currently, the focus is on transferring risk from pretty safe and standard mortgages, but the FHFA is pushing Fannie and Freddie to increase risk transfers on a broader array of mortgage types.

The scorecard also states that the effort to integrate Fannie and Freddie through the Common Securitization Platform and the Single Security should continue so that the Single Security is operational in 2018.  The scorecard emphasizes that the Platform should allow “for the integration of additional market participants in the future.” (6)  While this has been a design requirement from the get-go, I have heard through the grapevine that this element of the Platform has not been pursued so vigorously.  To my mind, it seems like a key component if we want to build the infrastructure for a healthy secondary mortgage market for the rest of the 21st century.

 

Does Housing Finance Reform Still Matter?

Ed DeMarco and Michael Bright

Ed DeMarco and Michael Bright

The Milken Institute’s Michael Bright and Ed DeMarco have posted a white paper, Why Housing Reform Still Matters. Bright was the principal author of the Corker-Warner Fannie/Freddie reform bill and DeMarco is the former Acting Director of the Federal Housing Finance Agency. In short, they know housing finance. They write,

The 2008 financial crisis left a lot of challenges in its wake. The events of that year led to years of stagnant growth, a painful process of global deleveraging, and the emergence of new banking regulatory regimes across the globe.

But at the epicenter of the crisis was the American housing market. And while America’s housing finance system was fundamental to the financial crisis and the Great Recession, reform efforts have not altered America’s mortgage market structure or housing access paradigms in a material way.

This work must get done. Eventually, legislators will have to resolve their differences to chart a modernized course for housing in our country. Reflecting upon the progress made and the failures endured in this effort since 2008, we have set ourselves to the task of outlining a framework meant to advance the public debate and help lawmakers create an achievable plan. Through a series of upcoming papers, our goal will be to not just foster debate but to push that debate toward resolution.

Before setting forth solutions, however, it is important to frame the issues and state why we should do this in the first place. In light of the growing chorus urging surrender and going back to the failed model of the past, our objective in this paper is to remind policymakers why housing finance reform is needed and help distinguish aspects of the current system that are worth preserving from those that should be scrapped. (1)

I agree with a lot of what they have to say.  First, we should not go back to “the failed model of the past,” and it amazes me that that idea has any traction at all. I guess political memories are as short as people say they are.

Second, “until Congress acts, the FHFA is stuck in its role of regulator and conservator.” (3) They argue that it is wrong to allow one individual, the FHFA Director, to dramatically reform the housing finance system on his own. This is true, even if he is doing a pretty good job, as current Director Watt is.

Third, I agree that any reform plan must ensure that the mortgage-backed securities market remain liquid; credit remains available in all submarkets markets; competition is beneficial in the secondary mortgage market.

Finally, I agree with many of the goals of their reform agenda: reducing the likelihood of taxpayer bailouts of private actors; finding a consensus on access to credit; increasing the role of private capital in the mortgage market; increasing transparency in order to decrease rent-seeking behavior by market actors; and aligning incentives throughout the mortgage markets.

So where is my criticism? I think it is just that the paper is at such a high level of generality that it is hard to find much to disagree about.  Who wouldn’t want a consensus on housing affordability and access to credit? But isn’t it more likely that Democrats and Republicans will be very far apart on this issue no matter how long they discuss it?

The authors promise that a detailed proposal is forthcoming, so my criticism may soon be moot. But I fear that Congress is no closer to finding common ground on housing finance reform than they have been for the better part of the last decade. The authors’ optimism that consensus can be reached is not yet warranted, I think. Housing reform may not matter because the FHFA may just implement a new regime before Congress gets it act together.

Republicans Ready for GSE Reform?

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Senator Richard Shelby (R-AL)

Senator Shelby (R-AL), the Chair of the Senate Committee on Banking, Housing and Urban Affairs, sent a letter to the U.S. Government Accountability Office regarding the future of Fannie Mae and Freddie Mac, sometimes known as the “enterprises.” It provides an interesting roadmap of Republican thinking about the appropriate role of the federal government in the mortgage market:

the FHFA [Federal Housing Finance Agency] has taken steps that appear to encourage a more active, rather than a reduced, role in the mortgage market for the enterprises. These steps include issuing proposed rules regarding the enterprises’ duty to serve, creating principle [sic] write-down requirements, lowering down-payment requirements, allowing allocation of revenues to the national housing trust fund despite the enterprise having no capital, and other actions. Moreover, the development of the common securitization platform, a joint venture established by the enterprises at the FHFA’s direction, raises a number of questions about the FHFA’s stated goal to gradually contract the enterprises’ dominant presence in the marketplace.

Initially, the purpose of the FHFA’s efforts, such as the common securitization platform, was to facilitate greater competition in the secondary mortgage market, but now it appears that the FHFA is no longer taking steps to enable the platform to be used by entities other than the enterprises.  Likewise, lowering the down-payment requirement for mortgages guaranteed by the enterprises will make the enterprises more competitive with others in the mortgage market, not less. Overall, these FHFA actions raise questions about the goals of the conservatorship and whether its ultimate purpose has changed.

To better understand the impact of these changes, I ask that the GAO study and report the extent to which the FHFA’s actions described above could influence:

  • The enterprises’ dominance in residential mortgage markets;
  • A potential increase in the cost of entry for future competitors to the enterprises;
  • Current and future financial demands on the Treasury;
  • Possible options for modifying the enterprises’ structures (1)

As I have stated previously, Congress and the Obama Administration have allowed the FHFA to reform Fannie and Freddie on its own, with very little oversight. Indeed, the only example of oversight one could really point to would be the replacement of Acting Director DeMarco with Director Watt, a former Democratic member of Congress. It is notable that Watt has continued many of the policies started by DeMarco, a Republican favorite. That being said, Shelby is right to point out that Watt has begun taking some modest steps that Democrats have favored, such as funding the housing trust fund and implementing a small principal-forgiveness program.

Housing finance reform is the one component of the post-financial crisis reform agenda that Congress and the Executive have utterly failed to address. It is unlikely that it will be addressed in the near future. But perhaps the FHFA’s independent steps to create a federal housing finance infrastructure for the 21st century will galvanize the political branches to finally act and implement their own vision, instead of ceding all of their power to the unelected leaders of an administrative agency.

 

Frannie Conservatorships: What A Long, Strange Trip It’s Been

The Federal Housing Finance Agency Office of Inspector General has posted a White Paper, FHFA’s Conservatorships of Fannie Mae and Freddie Mac: A Long and Complicated Journey. This White Paper on conservatorships updates a first one that OIG published in 2012. This one notes that over the past six years,

FHFA has administered two conservatorships of unprecedented scope and simultaneously served as the regulator for these large, complex companies that dominate the secondary mortgage market and the mortgage securitization sector of the U.S. housing finance industry. Congress granted FHFA sweeping conservatorship authority over the Enterprises. For example, as conservator, FHFA can exercise decision-making authority over the Enterprises’ multi-trillion dollar books of business; it can direct the Enterprises to increase the fees they charge to guarantee mortgage-backed securities; it can mandate changes to the Enterprises’ credit underwriting and servicing standards for single-family and multifamily mortgage products; and it can set policy governing the disposition of the Enterprises’ inventory of approximately 121,000 real estate owned properties. (2)

I was particularly interested by the foreward looking statements contained in this White Paper:

Director Watt has repeatedly asserted that conservatorship “cannot and should not be a permanent state” for the Enterprises. Director Watt has indicated that under his stewardship FHFA will continue the conservatorships and build a bridge to a new housing finance system, whenever that system is put into place by Congress. In this phase of the conservatorships, FHFA seeks to place more decision-making in the hands of the Enterprises. (3)

Those who have been hoping that the FHFA will act decisively in the face of Congressional inaction should let that dream go. And given that just about nobody believes (I still hope though) that there will be Congressional reform of Fannie and Freddie during the remainder of the Obama Administration, we must face the reality that we are stuck with the conservatorships and all of the risks that they foster for the foreseeable future. Today’s risks include historically high rates of mortgage delinquencies and exposure to defaults by counterparties like private mortgage insurers. As I have said before, the risks that Fannie and Freddie are nothing to laugh at. Let’s hope that the FHFA is up to managing them until Congress finally acts.

Housing Finance Reform at the AALS

The Financial Institutions and Consumer Financial Services Section and the Real Estate Transactions section of the American Association of Law Schools hosted a joint program at the AALS annual meeting on The Future of the Federal Housing Finance System. I moderated the session, along with Cornell’s Bob Hockett.
Former Representative Brad Miller (D-N.C.) keynoted.  Until recently he was a Senior Fellow, at the Center for American Progress and is now a Senior Fellow at the Roosevelt Institute. He was followed by four more great speakers:
The program overview was as follows:
The fate of Fannie Mae and Freddie Mac are subject to the vagaries of politics, regulation,public opinion, the economy, and not least of all the numerous cases that were filed in 2013 against various government entities arising from the placement of the two companies into conservatorship. All of these vagaries occur, moreover, against a backdrop of surprising public and political ignorance of the history and functions of the GSEs and their place in the broader American financial and housing economies. This panel will take the long view to identify how the American housing finance market should be structured, given all of these constraints. Invited speakers include academics, government officials and researchers affiliated to think tanks. They will discuss the various bills that have been proposed to reform that market including Corker-Warner and Johnson-Crapo. They will also address regulatory efforts by the Federal Housing Finance Agency to shape the federal housing finance system in the absence of Congressional reform.
During the presentations, I felt a bit of awe for the collective knowledge of the speakers.  The program also emphasized for me how much there always is to learn about a topic as complex as housing finance.
Laurie Goodman was kind enough to let me post her PowerPoint slides from the program. If you are looking for a good overview of the current state of housing finance reform, you will want to take a look at them.
I was a bit depressed by the slide titled, “Why GSE reform is unlikely before 2017:”
1. There is no sense of urgency: GSEs are profitable, current system is functioning.
2. Higher legislative priorities.
3. No easy answers as to what a new housing finance system should look like.
4. Bipartisan action requires compromise, and some believe they have more to lose than to gain by compromising in this arena.
While the slide depressed me, I think it offers a pretty realistic assessment of where we are. I hope Congress and the Obama Administration prove me wrong.