Tag Archives: GSE

The End of Private-Label Securities?

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Steve Jurvetson

Jamie Dimon, CEO of JPMorgan Chase

J.P. Morgan’s Securitized Products Weekly has a report, Proposed FRTB Ruling Endangers ABS, CMBS and Non-Agency RMBS Markets. This is one of those technical studies that have a lot of real world relevance to those of us concerned about the housing markets more generally.

The report analyzes proposed capital rules contained in the Fundamental Review of the Trading Book (FRTB). JPMorgan believes that these proposed rules would make the secondary trading in residential mortgage-backed securities unprofitable. It also believes that “there is no sector that escapes unscathed; capital will rise dramatically across all securitized product sectors, except agency MBS.” (1) It concludes that “[u]ltimately, in its current form, the FRTB would damage the availability of credit to consumers, reduce lending activity in the form of commercial mortgage and set back private securitization, entrenching the GSEs as the primary securitization vehicle in the residential mortgage market.” (1)

JPMorgan finds that the the impact of these proposed regulations on non-agency residential-mortgage backed securities (jumbos and otherwise) “is so onerous that we wonder if this was the actual intent of the regulators.” Without getting too technical, the authors thought “that the regulators simply had a mathematical mistake in their calculation (and were off by a factor of 100, but unfortunately this is what was intended.” (4) Because these capital rules “would make it highly unattractive for dealers to hold inventory in non-agency securities,” JPMorgan believes that they threaten the entire non-agency RMBS market. (5)

The report concludes with a policy takeaway:

Policymakers have at various times advocated for GSE reform in which the private sector (and private capital) would play a larger role. However, with such high capital requirements under the proposal — compared with capital advantages for GSE securities and a negligible amount of capital for the GSEs themselves — we believe this proposal would significantly set back private securitization, entrenching the GSEs as the primary securitization vehicle in the mortgage market. (5, emphasis removed)

I am not aware if JPMorgan’s concerns are broadly held, so it would important to hear others weigh in on this topic.

If the proposed rule is adopted, it is likely not to be implemented for a few years.  As a result, there is plenty of time to get the right balance between safety and soundness on the one hand and credit availability on the other. While the private-label sector has been a source of trouble in the past, particularly during the subprime boom, it is not in the public interest to put an end to it:  it has provided capital to the jumbo sector and provides much needed competition to Fannie, Freddie and Ginnie.

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.

Friday’s Government Reports

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  • The U.S. Census Bureau/HUD has released the New Residential Construction Statistics which show new building permits down slightly since August but 4.5% higher than Sept. 2014. Housing completions are up both month over month and year to year.
  • The New York Federal Reserve has released a paper: The Rescue of Fannie Mae and Freddie Mac and a related blog post: Evaluating the Rescue of  Fannie Mae and Freddie Mac in which the authors evaluate the now seven years and running government conservatorship which injected $187.5 billion into the two entities.  The authors conclude that the short term intervention was necessary “because of the central role of Fannie Mae and Freddie Mac in the U.S. mortgage market, and the GSEs’ interconnections with the rest of the global financial system.”  They go on to argue that the conservatorship was meant to be a temporary “time out” and characterize the lack of mortgage finance reform a “striking failure” and cite broad consensus that the GSEs should be replaced with a private system.

Hypothetically Reforming Fannie and Freddie

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Ben Turner

S&P issued a report, Fannie, Freddie, and the FHLB System: Plus Ca Change . . . The report opens, “Despite reform talk in the years since the U.S. housing crisis, Standard & Poor’s Ratings Services believes the likelihood of extraordinary government support for key U.S. housing government­-related entities (GREs) Fannie Mae, Freddie Mac, and the Federal Home Loan Bank (FHLB) system remains “almost certain” in case of need.” (1) Notwithstanding the fact that S&P expects that this extraordinary support will last well into the next presidential administration, S&P “can envisage three “tail risk” scenarios in which such support could become less likely under certain conditions, but view each of these scenarios as improbable.” (1) The three scenarios, which S&P characterizes as plausible, albeit improbable, are

  • An electoral sweep, with favorable macroeconomic conditions and few competing legislative priorities;
  • Court judgments, pursuant to shareholder lawsuits, forcing the legislators’ hand; or
  • A renewed housing market crisis, with one or more of these GREs viewed as more cause than cure. (4)

In the first scenario, “an election gives one party control of all three legislative actors (the president, House of Representatives, and Senate), precluding the need for bipartisan compromise to enact major reforms to Fannie and Freddie via legislation.” (4)

In the second, Fannie and Freddie shareholders win lawsuits that stem from the “U.S. Treasury’s decision to modify, in 2012, the Preferred Stock Purchase Agreements (PSPAs) governing the terms of its financial support to Fannie and Freddie . . ..” (4)

The final scenario,

is a renewed housing market crisis, on a scale at least similar to that of 2008. Like the other two scenarios, we don’t view this as likely, at least in the coming few years . . . perhaps as a result of the unfortunate confluence of several negative surprises- ­­including, for example, overreaction to Federal Reserve monetary policy normalization, terms­-of­-trade shocks (geopolitical conflicts that cause a rapid and dramatic spike in energy costs, perhaps), fresh financial sector  problems that suddenly tighten the sector’s funding costs, and an abnormally long spell of bad weather. (5)

This seems like a pretty reasonable analysis of the likelihood of reform for Fannie and Freddie. But that should not stop us from bemoaning Congressional inaction on this topic. Obviously, Congress is too ideologically driven to bridge the gap between the left and right, but the likelihood that we are building toward some new kind of crisis increases with time. I can’t improve on S&P’s analysis in this report, but I’m sure unhappy about what it means for the long-term health of our housing finance system.

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Credit Risk Transfer Deals

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A Syn

The Federal Housing Finance Agency released an Overview of Fannie Mae and Freddie Mac Credit Risk Transfer Transactions. It opens,

In 2012, the Federal Housing Finance Agency (FHFA) initiated a strategic plan to develop a program of credit risk transfer intended to reduce Fannie Mae’s and Freddie Mac’s (the Enterprises’) overall risk and, therefore, the risk they pose to taxpayers. In just three years, the Enterprises have made significant progress in developing a market for credit risk transfer securities, evidenced by the fact that they have already transferred significant credit risk on loans with over $667 billion of unpaid principal balance (UPB).

Credit risk transfer is now a regular part of the Enterprises’ business. The Enterprises are currently transferring a significant amount of the credit risk on almost 90% of the loans that account for the vast majority of their underlying credit risk. These loans constitute about half of all Enterprise loan acquisitions. Going forward, FHFA will continue to encourage the Enterprises to engage in large volumes of meaningful credit risk transfer through specific goals in the annual conservatorship scorecard and by working closely with Enterprise staff to develop and evaluate credit risk transfer structures. (2)

This is indeed good news for taxpayers and should reduce their exposure to future losses at Fannie and Freddie. There is still a lot of work to do, though, to get that risk level as low as possible. The report notes that these transactions have not yet been done for adjustable-rate mortgages or 15 year mortgages. Most importantly, the report cautions that

Because the programs have not been implemented through an entire housing price cycle, it is too soon to say whether the credit risk transfer transactions currently ongoing will make economic sense in all stages of the cycle. Specifically, we cannot know the extent to which investors will continue to participate through a housing downturn. Additionally, the investor base and pricing for these transactions could be affected by a higher interest rate environment in which other fixed-income securities may be more attractive alternatives. (22)

Taxpayers are exposed to many heightened risks during Fannie and Freddie’s conservatorship, such as operational risk. These risk transfer transactions are thus particularly important while the two companies linger on in that state.

Tuesday’s Regulatory & Legislative Round-Up

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  • Fannie Mae announced HomeReady – a new affordable lending product which will be rolled out later in the year.  The program includes features designed to make it more flexible for lenders and buyers alike.  For lenders Desktop Underwriter (DU) allows lenders to make credit risk, eligibility and loan availability assessment in one tool.  HomeReady loans also promise simplified execution due to the ability to commingle them with standard loans into Mortgaged Backed Security polls.  Purchasers are able to put as little as 3% down, and are able to use rental income from the property and non-borrower household income to meet the requirements.

Principal-ed Reduction

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Torn Dollar

 

The Urban Institute’s Housing Finance Policy Center has issued a report, Principal Reduction and the GSEs: The Moment for a Big Impact Has Passed. It opens,

The Federal Housing Finance Agency (FHFA) prohibits Fannie Mae and Freddie Mac (the government-sponsored enterprises, or GSEs) from unilaterally reducing the principal balance of loans that they guarantee, known as principal reduction. When director Ed DeMarco established the prohibition, he was concerned that reducing principal would cost the GSEs too much, not only in setting up the systems required to implement it, but also— and to him more important — in encouraging borrowers to default in order to receive the benefit. DeMarco’s position generated significant controversy, as advocates viewed principal reduction as a critical tool for reducing borrower distress and pointed out that the program the Obama administration had put forward to provide the relief had largely eliminated the cost to the GSEs, including the moral hazard. We believe that at the time the advocates had the better side of the argument.

The FHFA is now revisiting that prohibition, though in a very different economic environment than the one faced by Director DeMarco. Home prices are up 35.4 percent since the trough in 2011, adding $5 trillion in home equity and reducing the number of underwater homeowners from a peak of 25 percent to 10 percent. This means that far fewer borrowers would likely benefit under a GSE principal reduction program today. (1, footnote omitted)

Principal reduction was highly disfavored at the start of the financial crisis as it was perceived as a sort of giveaway to irresponsible borrowers. Some academics have disputed this characterization, but it probably remains a political reality.

In any event, I think this report has the analysis of the current situation right — the time for principal reduction has passed. But it is worth considering the conditions under which it might be appropriate in the future (for that next crisis, or the one after that). The authors make four  assumptions for a politically feasible principal reduction program:

  1. borrowers must be delinquent at the time the program is announced, in order to avoid the moral hazard of encouraging borrowers to default;
  2. borrowers must be underwater;
  3. the house must be owner-occupied; and
  4. the principal reduction is in the economic interest of Fannie and Freddie.

It is worth noting that during the Great Depression, the federal government figured out ways to reduce the burden of rapidly dropping house prices on lenders and borrowers alike without resorting to principal reduction much. Borrowers benefited from longer repayment terms and lower interest rates. Below-market interest rates are similar to principal reduction because they also reduce monthly costs for borrowers. They are also politically more feasible. It would be great to have a Plan B stored away at the FHFA, the FHA and the VA that outlines a systematic response to a nation-wide drop in housing prices. It could involve principal reduction but it does not need to.