Tag Archives: GSE

How Tight Is The Credit Box?

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Laurie Goodman of the Urban Institute’s Housing Finance Policy Center has posted a working paper, Quantifying the Tightness of Mortgage Credit and Assessing Policy Actions. The paper opens,

Mortgage credit has become very tight in the aftermath of the financial crisis. While experts generally agree that it is poor public policy to make loans to borrowers who cannot make their payments, failing to make mortgages to those who can make their payments has an opportunity cost, because historically homeownership has been the best way to build wealth. And, default is not binary: very few borrowers will default under all circumstances, and very few borrowers will never default. The decision where to draw the line—which mortgages to make—comes down to what probability of default we as a society are prepared to tolerate.

This paper first quantifies the tightness of mortgage credit in historical perspective. It then discusses one consequence of tight credit: fewer mortgage loans are being made. Then the paper evaluates the policy actions to loosen the credit box taken by the government-sponsored enterprises (GSEs) and their regulator, the Federal Housing Finance Agency (FHFA), as well as the policy actions taken by the Federal Housing Administration (FHA), arguing that the GSEs have been much more successful than the FHA. The paper concludes with the argument that if we don’t solve mortgage credit availability issues, we will have a much lower percentage of homeowners because a larger share of potential new homebuyers will likely be Hispanic or nonwhite—groups that have had lower incomes, less wealth, and lower credit scores than whites. Because homeownership has traditionally been the best way for households to build wealth, the inability of these new potential homeowners to buy could increase economic inequality between whites and nonwhites. (1)

Goodman has been making the case for some time that the credit box is too tight. I would have liked to see a broader discussion in the paper of policies that could further loosen credit. What, for instance, could the Consumer Financial Protection Bureau do to encourage more lending? Should it be offering more of a safe harbor for lenders who are willing to make non-Qualified Mortgage loans? The private-label mortgage-backed securities sector has remained close to dead since the financial crisis.  Are there ways to bring some life — responsible life — back to that sector? Why aren’t portfolio lenders stepping into that space? What would they need to do so?

When the Qualified Mortgage rule was being hashed out, there was a debate as to whether there should be any non-Qualified Mortgages available to borrowers.  Some argued that every borrower should get a Qualified Mortgage, which has so many consumer protection provisions built into it. I was of the opinion that there should be a market for non-QM although the CFPB would need to monitor that sector closely. I stand by that position. The credit box is too tight and non-QM could help to loosen it up.

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.

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.

Is Trump a Negative for the Housing Market?

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TheStreet.com quoted me in Is Trump a Negative for the Housing Market? It opens,

At first blush, real estate industry professionals saw a lot to like with the election of Donald Trump to the presidency. Trump was and is pro-business, and he made his billions in the commercial real estate sector. This, real estate pro’s thought, is a guy who has the industry’s back.

But not every real estate specialist views the Trump presidency as a net positive.

Take Tommy Sowers, from GoldenKey, a real estate technology platform with locations in San Francisco and Durham, N.C.

Sowers holds a “strong belief” that President Donald Trump will actually be detrimental for the real estate industry, making it less affordable for Americans to buy homes.

“During the campaign, Donald Trump spoke about home ownership numbers being the lowest they have ever been since 1965 at 62.9%,” says Sowers. In a nation where homeownership is seen as synonymous with the American dream, it’s no surprise that he wanted to highlight this low rate and suggest ways to increase it, he says. “The reality is that his policies and actions indicate the opposite,” he says.

Sowers lists several reasons why Trump may not be the industry savior some real estate professionals might have counted on:

Rising interest rates – “While this responsibility sits with the Federal Reserve, which has kept interest rates low in recent years, Trump has blasted them for doing this stating that they are ‘creating a false economy,'” Sowers explains. “Most economists predict that interest rates will now rise in 2017.”

Dismantling Government Sponsored Enterprises (GSEs) – “During the 2008 financial crisis, the taxpayer bought out Fannie Mae and Freddie Mac and now under government control they play a greater role than before the crisis in sustaining real estate sales and providing liquidity to the housing market,” Sowers says. “Trump wants to privatize them – a shake up to this arrangement could mean that banks stop offering the lower cost 30-year fixed rate mortgages.”

Cutting FHA home insurance – This was one of Trump’s first acts in office, making it more expensive for borrowers to insure their homes, Sowers notes. “His pick for Treasury Secretary, Steve Mnuchin, wants to limit the mortgage interest deduction,” he adds. “This may not impact the average US homebuyer but in many areas across the country the average home is above the threshold of $500,000.”

Immigrant confidence – “We are a nation of immigrants and many are here legally with green cards,” Sowers states. “His latest immigration policy has sent shock waves to foreign investors and will likely stunt confidence in immigrants that are here legally from buying a home.” President Trump has said he hopes to encourage further building with the National Association of Home Builders, he adds. “However, with so many immigrants working in the construction industry, his policies are likely decrease the speed of development,” Sowers says. “With less new homes being built, people are likely to wait and not move or buy a new house.”

There are other areas of concern, experts say. For example, reducing government regulations may thrill real estate professionals, along with buyers and sellers, but industry experts say that will actually hurt the U.S. housing market.

“Trump’s commitment to weakening the Consumer Financial Protection Bureau and the consumer protection provisions of the Dodd-Frank Act will have a harmful impact on the housing market in the long run,” predicts David Reiss, a law professor at the Brooklyn Law School, in Brooklyn, N.Y.

Reiss says Trump and his allies argue that Dodd-Frank has cut off credit, but the numbers don’t bear that out. “Mortgage rates are near their all-time lows,” he says. “Dodd-Frank, which created the CFPB and mandated the Qualified Mortgage and Ability-to-Repay rules, put a brake on most of the predatory behavior that characterized the mortgage market before the financial crisis. Getting rid of Dodd-Frank and the CFPB may loosen mortgage lending a bit in the short term, but in the long term it will allow predatory lenders to return to the mortgage market, big-time.”

“We will the see bigger booms followed by bigger busts,” he adds. “That kind of volatility is not good for the housing market in the long term.”

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.

Mortgage Bankers and GSE Reform

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photo by Daniel Case

The Mortgage Bankers Association has released GSE Reform Principles and Guardrails. It opens,

This paper serves as an introduction to MBA’s recommended approach to GSE reform. Its purpose is to outline what MBA views as the key components of an end state, the principles that MBA believes should be incorporated in any future system, the “guardrails” we believe are necessary in our end state, as well as emphasize the need to ensure a smooth transition to the new secondary mortgage market. (1)

While there is very little that is new in this document, it is useful, nonetheless, as a statement of the industry’s position. The MBA has promulgated the following principles for housing finance reform:

  • The 30-year, fixed-rate, pre-payable single-family mortgage and longterm financing for multifamily mortgages should be preserved.
  • A deep, liquid TBA market for conventional single-family loans must be maintained. Eligible MBS backed by a well-defined pool of single-family mortgages or multifamily mortgages should receive an explicit government guarantee, funded by appropriately priced insurance premiums, to attract global capital and preserve liquidity during times of stress. The government guarantee should attach to the eligible MBS only, not to the guarantors or their debt.
  • The availability of affordable housing, both owned and rented, is vitally important; these needs should be addressed along a continuum, incorporating both single- and multifamily approaches for homeowners and renters.
  • The end-state system should facilitate equitable, transparent and direct access to secondary market programs for lenders of all sizes and business models.
  • A robust, innovative and purely private market should be able to co-exist alongside the government-backed market.
  • Existing multifamily financing executions should be preserved, and new options should be permitted.
  • The end-state system should rely on strong, transparent regulation and private capital (including primary-market credit enhancement such as mortgage insurance [MI] and lender recourse, or other available forms of credit risk transfer) primarily assuming most of the risk.
  • While the system will primarily rely on private capital, there should be a provision for a deeper level of government support in the event of a systemic crisis.
  • There should be a “bright line” between the primary and secondary mortgage markets, applying to both allowable activities and scope of regulation.
  • Transition risks to the new end-state model should be minimized, with special attention given to avoiding any operational disruptions. (3-4)

This set of principles reflect the bipartisan consensus that had been developing around the Johnson-Crapo and Corker-Warner housing reform bills. The ten trillion dollar question, of course, is whether the Trump Administration and Congressional leaders like Jeb Hensarling (R-TX), the Chair of the House Banking Committee, are going to go along with the mortgage finance industry on this or whether they will push for a system with far less government involvement than is contemplated by the MBA.