Tag Archives: Federal Housing Finance Agency

Comparison Shopping Savings in Mortgage Market

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Alexei Alexandrov and Sergei Koulayev of the Consumer Financial Protection Bureau have posted a working paper, No Shopping in the U.S. Mortgage Market: Direct and Strategic Effects of Providing Information to SSRN. The paper is the first to answer the question, “How much do consumers lose by not shopping enough for mortgages?” (5) They find that “for the average consumer, the the difference between the actual and the lowest offered rate amounted to an extra $300 per year.” (Id.)

The abstract reads,

We document and analyze price dispersion in the U.S. mortgage market. We find significant price dispersion in posted prices in the retail channel: for example, a consumer with a prime credit score and with a 20% down payment might see a spread in interest rates of 50 basis points, controlling for all relevant consumer/property characteristics, including discount points. We also show, from survey evidence, that close to half of consumers did not shop before taking out a mortgage, and worse, many consumers do not seem to realize that there is price dispersion. Using a proprietary dataset of lenders’ ratesheets, we estimate an equilibrium model of costly search where a share of consumers holds incorrect beliefs regarding price dispersion. Whereas high search costs is one reason behind the lack of search, we show that non-price preferences also play an important role in preventing consumers from searching more; and so an effective policy would target both. In one of our counterfactuals, we show that eliminating non-price preferences results in savings of about $9 billion dollars a year.

In addition to its significant finding on a new topic (one that should have policy implications for the Consumer Financial Protection Bureau), the paper also demonstrates the value of government research on the mortgage markets.

The paper relies on data from the National Survey of Mortgage Originations. The NSMO is a survey designed by the CFPB and the Federal Housing Finance Agency.  It is sent out on a quarterly basis to a nationally representative sample of recent mortgage borrowers. Jeb Hensarling (R-TX), the Chair of the House Financial Services Committee, has introduced legislation to stop the CFPB from conducting research on the mortgage markets. That would be a bad result for consumers.

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.

This Is What GSE Reform Looks Like

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Scene from Young Frankenstein

The Federal Housing Finance Agency’s Division of Conservatorship release an Update on Implementation of the Single Security and the Common Securitization Platform. As I had discussed last week, housing finance reform is proceeding apace from within the FHFA notwithstanding assertions by members of Congress that they will take the lead on this. The Update provides some background for the uninitiated:

The Federal Housing Finance Agency’s (FHFA) 2014 Strategic Plan for the Conservatorships of Fannie Mae and Freddie Mac includes the strategic goal of developing a new securitization infrastructure for Fannie Mae and Freddie Mac (the Enterprises) for mortgage loans backed by 1- to 4-unit (single-family) properties. To achieve that strategic goal, the Enterprises, under FHFA’s direction and guidance, have formed a joint venture, Common Securitization Solutions (CSS). CSS’s mandate is to develop and operate a Common Securitization Platform (CSP or platform) that will support the Enterprises’ single-family mortgage securitization activities, including the issuance by both Enterprises of a common single mortgage-backed security (to be called the Uniform Mortgage-Backed Security or UMBS). These securities will finance the same types of fixed-rate mortgages that currently back Enterprise-guaranteed securities eligible for delivery into the “To-Be-Announced” (TBA) market. CSS is also mandated to develop the platform in a way that will allow for the integration of additional market participants in the future.

The development of and transition to the new UMBS constitute the Single Security Initiative. FHFA has two principal objectives in undertaking this initiative. The first objective is to establish a single, liquid market for the mortgage-backed securities issued by both Enterprises that are backed by fixed-rate loans. The second objective is to maintain the liquidity of this market over time. Achievement of these objectives would further FHFA’s statutory obligation and the Enterprises’ charter obligations to ensure the liquidity of the nation’s housing finance markets. The Single Security Initiative should also reduce the cost to Freddie Mac and taxpayers that has resulted from the historical difference in the liquidity of Fannie Mae’s Mortgage-Backed Securities (MBS) and Freddie Mac’s Participation Certificates (PCs). (1, footnote omitted)

This administratively-led reform of Fannie and Freddie is not necessarily a bad thing, particularly because the executive and legislative branches have not taken up reform in any serious way since the two companies entered conservatorship in 2008. While Congress could certainly step up to the plate now, it is worth understanding just how far along the FHFA is in its transformation of the two companies:

Upon the implementation of Release 2, CSS will be responsible for bond administration of approximately 900,000 securities, which are backed by almost 26 million home loans having a principal balance of over $4 trillion. CSS’S responsibilities related to security issuance, security settlement, bond administration and disclosures were described in the September 2015 Update on the Common Securitization Platform. The Enterprises and investors, along with home owners and taxpayers, will rely on the operational integrity and resiliency of the CSP to ensure the smooth functioning of the U.S. housing mortgage market. (8)

That is, upon the implementation of Release 2, the merger of Fannie and Freddie into Frannie will be complete.

Fannie + Freddie = Frannie

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The Federal Housing Finance Agency released its 2016 Scorecard Progress Report. It contains some interesting information about the FHFA’s ongoing efforts to reshape Fannie and Freddie notwithstanding the inaction of Congress. These efforts are not broadcast very clearly, but they are documented nonetheless:

Maintaining a high degree of uniformity in the prepayment speeds of the Enterprises’ mortgage-backed securities is important to the success of the Single Security Initiative. Accordingly, the 2016 Scorecard called for the Enterprises to assess new or revised Enterprise programs, policies, and practices for their effect on the cash flows of mortgage-backed securities eligible for financing through TBA market.

In July 2016, FHFA published An Update on Implementation of the Single Security and the Common Securitization Platform (July 2016 Update), which included a description of specific steps FHFA would take and steps FHFA would require the Enterprises to take to ensure the continued convergence of prepayment speeds across the Enterprises’ mortgage-backed securities. The July 2016 Update indicated that each Enterprise would be required to submit for FHFA review any proposed changes the Enterprise believed could have a measureable effect on the prepayment rates and performance of TBA-eligible securities, including its analysis of any effects on prepayment speeds and/or removals of delinquent mortgage loans from securities under a range of scenarios. In addition, FHFA monitors Enterprise programs, policies, and practices that are initially determined to have no significant effect on prepayment rates or security performance and works with the Enterprises to address any unexpected effects as they arise. (25)

While this is all very technical stuff, it boils down to the effort of the FHFA to make Fannie and Freddie’s securities indistinguishable from each other so they can be treated as a Single Security. Once this process is completed, we will enter a new phase for the GSEs. The two companies wont really be competitors, they will be like identical twins.

Senators Corker and Warner are trying to resuscitate a housing finance reform bill, but this administrative reform is proceeding apace through ten years of Congressional inaction. The FHFA’s actions will likely limit the choices that Congress will have in very real ways, assuming Congress can ever get itself to act.

This is not necessarily a bad thing, it is just good to name it for what it is: housing finance reform implemented by an independent agency, not by a democratically elected Congress.

Is There a Bipartisan Fix for Fannie and Freddie?

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photo by DonkeyHotey

The Hill published my latest column, Congress May Have Finally Found a Bipartisan Fix to Fannie and Freddie. It reads,

It is welcome news to hear that Sens. Bob Corker (R-Tenn.) and Mark Warner (D-Va.) are looking to craft a bipartisan solution to the problem of Fannie Mae and Freddie Mac. The two massive mortgage companies have been in conservatorship since 2008 when they were on the verge of failing. At that time, nobody, just nobody, believed that they would still be in conservatorship nearly a decade later.

But here we are. Resolving this situation is of great importance to the financial well-being of the nation. These two companies guarantee trillions of dollars worth of mortgages and operate like black boxes, run by employees who don’t have a clear mission from their multiple masters in government.

This is the recipe for some kind of crisis.Maybe they will not underwrite their mortgage-backed securities properly. Maybe they will undertake a risky hedging strategy. We just don’t know, but there is reason to think that gargantuan organizations that have been in limbo for ten years may have developed all sorts of operational pathologies.

There have been a couple of serious attempts in the Senate to craft a long-term solution to this problem, but it was not a high priority for the Obama Administration and does not yet appear to be a high priority for the Trump Administration. Deep ideological divisions over the appropriate role of the government in the mortgage have also stymied progress on reform.

Rep. Jeb Hensarling (R-Texas), chairman of the House Financial Services Committee, leads a faction that wants to dramatically reduce the role of the government in the mortgage market. Sen. Elizabeth Warren (D-Mass.) leads a faction that wants to ensure that the government plays an active role in making homeownership, and housing more generally, more affordable to low- and moderate-income households. At this point, it is not clear whether a sufficiently broad coalition could be cobbled together to overcome the opposition to a compromise at the two ends of the spectrum.

2017 presents an opportunity to push reform forward, however. The terms of the conservatorship were changed in 2012 to require that the Fannie and Freddie reduce their capital cushion to zero by the end of this year. That means that if Fannie or Freddie has even one bad quarter and suffers losses, something that is bound to happen sooner or later, they would technically require a bailout from Treasury.

Now, such a bailout would not be such a terrible thing from a policy perspective as Fannie and Freddie have paid tens of billions of dollars more to the Treasury than they received in the bailout. But politically, a second bailout of Fannie or Freddie would be toxic for those who authorize it.

Some are arguing that we should kick the can down the housing finance reform road once again, by allowing Fannie and Freddie to retain some of their capital to protect them from such a scenario. But Corker and Warner seem to want to use the Dec. 31, 2017 end date to focus minds in Congress. They, along with some other colleagues, have warned Fannie and Freddie’s conservator, Federal Housing Finance Agency Director Mel Watt, not to increase the capital cushion for the two companies. They claim that it is Congress’ prerogative to make this call.

The conventional wisdom is that the stars have not aligned to make housing finance reform politically viable in the short term. The conventional wisdom is probably right because the housing finance system is working well enough for now. Mortgage rates are very low and while access to credit is a bit tight, it is not so tight that it is making headlines. So perhaps Senators Corker and Warner are right to use the fear factor of future bailouts as a goad to action.

Housing finance reform requires statesmanship because there are no short-term gains that will accrue to the politicians that lead it. And the long-term gains will be very diffuse – nobody will praise them for the crises that were averted by their actions to create a housing finance system fit for the 21st century. But this work is of great importance and far-thinking leaders on both sides of the aisle should support a solution that takes Fannie and Freddie out of the limbo of conservatorship.

It will require compromise and an acceptance of the fact that the perfect is the enemy of the good. But if compromise is reached, it may help to avoid another catastrophe that will be measured in the hundreds of billions of dollars. And it will ensure that we have a mortgage market that meets the needs of America’s families.

Fannie and Freddie’s Credit Risk Transfers

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The Urban Institute’s Housing Finance Policy Center has released its February 2017 Housing Finance at a Glance Chartbook, always a great resource for housing geeks. Each Chartbook highlights one topic. This one focuses on GSE credit risk transfers, an important but technical subject:

The GSE’s credit risk transfer (CRT) program is growing and tapping into a more diverse investor base, reducing the costs of CRTs and improving liquidity in this market. At the same time, the continued reliance on back-end transactions is cause for concern
.
Freddie Mac‘s first two capital markets CRT transactions of 2017 have been different from previous Structured Agency Credit Risk (STACR) transactions in one important way. Unlike the pre-2017 deals, in which the first loss piece (Tranche B) was 100 basis points thick, the first loss piece (Tranche B2) in the latest transactions is only 50 basis points thick while second loss piece (B1) is also 50 basis points thick. Splitting the old B tranche more granularly in this manner is a noteworthy development for a few reasons.
Although this is hardly the first improvement the GSEs have made to their back-end CRT execution, it is an important one. Splitting the offering into more granular risk buckets will force investors to price the tranches more accurately, thus facilitating more precise price discovery of credit risk. More granular tranching will also help increase the demand for STACR securities. Investors who were previously willing, but unable to invest in the B tranche because investment guidelines prohibited them from taking first loss credit risk will now instead be able to invest in the second loss B1 tranche, which offers a higher expected returns than the previous second loss tranche (M2). Growing and diversifying the investor base is important because it makes the bidding process more efficient and minimizes the cost of risk transfer for Freddie Mac and the taxpayer. A larger, more diverse investor base also bodes well for the liquidity of the CRT market, which is still in its infancy.
Clearly, these innovations are important steps towards improving the efficiency of back-end CRT. But at the same time, they must be viewed in the context of the broader objectives of credit risk transfer and housing finance reform which have near unanimous support: reducing taxpayer risk, passing the benefits of CRT on to borrowers, facilitating broad availability of credit through the economic cycle, ensuring adequate access for lenders of all sizes, and promoting a variety of CRT executions, including at the front end to facilitate an understanding of which programs are most favorable under which circumstances.
Although the GSEs have experimented with front end mechanisms like lender recourse and deeper MI, these transactions have been few and far between, and with very little transparency about pricing and other terms. But more importantly, the GSEs’ continued and significant reliance on back-end capital markets transactions doesn’t put us on a path towards achieving some of the program objectives outlined above. This matters because it signals that the GSEs’ current strategy for credit risk transfer, which revolves largely around the success of back-end transactions, may ultimately keep the program from realizing its full potential. (5)
 So, all in all Fannie and Freddie are taking a step in the right direction, but it is just a small step on the road to housing finance reform.

GSE Investors’ Hidden Win

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Judge Brown

The big news yesterday was that the US Court of Appeals for the DC Circuit ruled in the main for the federal government in Perry Capital v. Mnuchin, one of the major cases that investors brought against the federal government over the terms of the Fannie and Freddie conservatorships.

In a measured and carefully reasoned opinion, the court rejected most but not all of the investors’ claims.  The reasoning was consistent with my own reading of the broad conservatorship provisions of the Housing and Economic Recover Act of 2008 (HERA).

Judge Brown’s dissent, however, reveals that the investors have crafted an alternative narrative that at least one judge finds compelling. This means that there is going to be some serious drama when this case ultimately wends its way to the Supreme Court. And there is some reason to believe that a Justice Gorsuch might be sympathetic to this narrative of government overreach.

Judge Brown’s opinion indicts many aspects of federal housing finance policy, broadly condemning it in the opening paragraph:

One critic has called it “wrecking-ball benevolence,” James Bovard, Editorial, Nothing Down: The Bush Administration’s Wrecking-Ball Benevolence, BARRON’S, Aug. 23, 2004, https://tinyurl.com/Barrons-Bovard; while another, dismissing the compassionate rhetoric, dubs it “crony capitalism,” Gerald P. O’Driscoll, Jr., Commentary, Fannie/Freddie Bailout Baloney, CATO INST., https://tinyurl.com/Cato-O-Driscoll (last visited Feb. 13, 2017). But whether the road was paved with good intentions or greased by greed and indifference, affordable housing turned out to be the path to perdition for the U.S. mortgage market. And, because of the dominance of two so-called Government Sponsored Entities (“GSE”s)—the Federal National Mortgage Association (“Fannie Mae” or “Fannie”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac” or “Freddie,” collectively with Fannie Mae, the “Companies”)—the trouble that began in the subprime mortgage market metastasized until it began to affect most debt markets, both domestic and international. (dissent at 1)

While acknowledging that the Fannie/Freddie crisis might justify “extraordinary actions by Congress,” Judge Brown states that

even in a time of exigency, a nation governed by the rule of law cannot transfer broad and unreviewable power to a government entity to do whatsoever it wishes with the assets of these Companies. Moreover, to remain within constitutional parameters, even a less-sweeping delegation of authority would require an explicit and comprehensive framework. See Whitman v. Am. Trucking Ass’ns, Inc., 531 U.S. 457, 468 (2001) (“Congress . . . does not alter the fundamental details of a regulatory scheme in vague terms or ancillary provisions—it does not, one might say, hide elephants in mouseholes.”) Here, Congress did not endow FHFA with unlimited authority to pursue its own ends; rather, it seized upon the statutory text that had governed the FDIC for decades and adapted it ever so slightly to confront the new challenge posed by Fannie and Freddie.

*     *     *

[Congress] chose a well-understood and clearly-defined statutory framework—one that drew upon the common law to clearly delineate the outer boundaries of the Agency’s conservator or, alternatively, receiver powers. FHFA pole vaulted over those boundaries, disregarding the plain text of its authorizing statute and engaging in ultra vires conduct. Even now, FHFA continues to insist its authority is entirely without limit and argues for a complete ouster of federal courts’ power to grant injunctive relief to redress any action it takes while purporting to serve in the conservator role. See FHFA Br. 21  (2-3)

What amazes me about this dissent is how it adopts the decidedly non-mainstream history of the financial crisis that has been promoted by the American Enterprise Institute’s Peter Wallison.  It also takes its legislative history from an unpublished Cato Institute paper by Vice-President Pence’s newly selected chief economist, Mark Calabria and a co-author.  There is nothing wrong with a judge giving some context to an opinion, but it is of note when it seems as one-sided as this. The bottom line though is that this narrative clearly has some legs so we should not think that this case has played itself out, just because of this decision.