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.

Are The Stars Aligning For Fannie And Freddie Reform?

Law360 published my op ed, Are The Stars Aligning For Fannie And Freddie Reform? It reads,

There has been a lot of talk of the closed-door discussions in the Senate about a reform plan for Fannie Mae and Freddie Mac, the two mammoth housing finance government-sponsored enterprises. There has long been a bipartisan push to get the two entities out of their conservatorships with some kind of permanent reform plan in place, but the stars never aligned properly. There was resistance on the right because of a concern about the increasing nationalization of the mortgage market and there was resistance on the left because of a concern that housing affordability would be unsupported in a new system. It looks like the leader of that right wing, House Financial Services Committee Chairman Jeb Hensarling, R-Texas, has indicated that he is willing to compromise in order to create a “sustainable housing finance system.” The question now is whether those on the left are also willing to compromise in order to put that system on a firm footing for the 21st century.

In a speech at the National Association of Realtors, Hensarling set forth a set of principles that he would be guided by:

  • Fannie Mae and Freddie Mac must be wound down and their charters repealed;
  • Securitizers need strong bank-like capital and community financial institutions must be able to compete on a level playing field;
  • Any new government affordable housing program needs to at least be on budget, be results-based and target actual homebuyers for the purpose of buying a home they can actually afford to keep;
  • The Federal Housing Administration must return to its traditional role of serving the first-time homebuyer and low- and moderate-income individuals.

I am not yet sure that all of the stars are now aligned for Congress to pass a GSE reform bill. But Hensarling’s change of heart is a welcome development for those of us who worry about some kind of slow-moving train wreck in our housing finance system. That system has been in limbo for nearly a decade since Fannie and Freddie were placed in conservatorship, with no end in sight for so long. Ten years is an awfully long time for employees, regulators and other stakeholders to play it by ear in a mortgage market measured in the trillions of dollars.

Even with a broad consensus on the need for (or even just the practical reality of) a federal role in housing finance, there are a lot of details that still need to be worked out. Should Fannie and Freddie be replaced with many mortgage-backed securities issuers whose securities are guaranteed by some arm of the federal government? Or should Fannie and Freddie become lender-owned mutual insurance entities with a government guarantee of the two companies? These are just two of the many options that have been proposed over the last 10 years.

Two housing finance reform leaders, Sens. Bob Corker, R-Tenn., and Mark Warner, D-Va., appear to favor some version of the former while Hensarling seems to favor the latter. And Hensarling stated his unequivocal opposition to some form of a “recap and release” plan, whereas Corker and Warner appear to be considering a plan that recapitalizes Fannie and Freddie and releases them back into private ownership, to the benefit of at least some of the companies’ shareholders. The bottom line is that there are still major differences among all of these important players, not to mention the competing concerns of Sen. Elizabeth Warren, D-Mass., and other progressives. Warren and her allies will seek to ensure that the federal housing system continues to support meaningful affordable housing initiatives for both homeowners and renters.

Hensarling made it clear that he does not favor a return to the status quo — he said that the hybrid GSE model “cannot be saved, it cannot be salvaged, it must not be resurrected, and needs to be scrapped.” But Hensarling also made it clear that he will negotiate and compromise. This represents a true opening for a bipartisan bill. For everyone on the left and the right who are hoping to create a sustainable housing finance system for the 21st century, let’s hope that his willingness to compromise is widely shared in 2018.

I am now cautiously optimistic that Congress can find some common ground. With Hensarling on board, there is now broad support for a government role in the housing sector. There is also broad support for a housing finance infrastructure that does not favor large financial institutions over small ones. Spreading the risk of default to private investors — as Fannie and Freddie have been doing for some time now under the direction of their regulator — is also a positive development, one with many supporters. Risk sharing reduces the likelihood of a taxpayer bailout in all but the most extreme scenarios.

There are still some big sticking points. What should happen with the private investors in Fannie and Freddie? Will they own part of the new housing finance infrastructure? While the investors have allies in Congress, there does not seem to be a groundswell of support for them on the right or the left.

How much of a commitment should there be to affordable housing? Hensarling acknowledges that the Federal Housing Administration should serve first-time homebuyers and low- and moderate-income individuals, but he is silent as to how big a commitment that should be. Democrats are invested in generating significant resources for affordable housing construction and preservation through the Affordable Housing Trust Fund. Hensarling appears to accept this in principle, while cautioning that any “new government affordable housing program needs to at least be on budget, results based, and target actual homebuyers for the purpose of buying a home they can actually afford to keep.” Democrats can work with Hensarling’s principles, although the extent of the ultimate federal funding commitment will certainly be hotly contested between the parties.

My cautious optimism feels a whole lot better than the fatalism I have felt for many years about the fate of our housing finance system. Let’s hope that soon departing Congressman Hensarling and Sen. Corker can help focus their colleagues on creating a housing finance system for the 21st century, one with broad enough support to survive the political winds that are buffeting so many other important policy areas today.

Rethinking FHA Insurance

The Congressional Budget Office issued a report on Options to Manage FHA’s Exposure to Risk from Guaranteeing Single-Family Mortgages. FHA insurance stands out from other forms of mortgage insurance because it guarantees all of a lender’s loss, rather than just a portion of it. It is certainly a useful exercise to determine whether the FHA could reduce its exposure to those potential credit losses while also making home loans available to people who would otherwise have difficulty accessing them. This report evaluates the options available to the FHA:

The Federal Housing Administration (FHA) insures the mortgages of people who might otherwise have trouble getting a loan, particularly first-time homebuyers and low-income borrowers seeking to purchase or refinance a home. During and just after the 2007–2009 recession, the share of mortgages insured by FHA grew rapidly as private lenders became more reluctant to provide home loans without an FHA guarantee of repayment. FHA’s expanded role in the mortgage insurance market ensured that borrowers could continue to have access to credit. However, like most other mortgage insurers, FHA experienced a spike in delinquencies and defaults by borrowers.

Recently, mortgage borrowers with good credit scores, large down payments, or low ratios of debt to income have started to see more options in the private market. The Congressional Budget Office estimates that the share of FHA-insured mortgages going to such borrowers is likely to keep shrinking as credit standards in the private market continue to ease. That change would leave FHA with a riskier pool of borrowers, creating risk-management challenges similar to the ones that contributed to the agency’s high levels of insurance claims and losses during the recession.

This report analyzes policy options to reduce FHA’s exposure to risk from its program to guarantee single-family mortgages, including creating a larger role for private lenders and restricting the availability of FHA’s guarantees. The options are designed to let FHA continue to fulfill its primary mission of ensuring access to credit for first-time homebuyers and low-income borrowers.

*     *     *

What Policy Options Did CBO Analyze?

Many changes have been proposed to reduce the cost of risk to the federal government from FHA’s single-family mortgage guarantees. CBO analyzed illustrative versions of seven policy options, which generally represent the range of approaches that policymakers and others have proposed:

■ Guaranteeing some rather than all of the lender’s losses on a defaulted mortgage;

■ Increasing FHA’s use of risk-based pricing to tailor up-front fees to the riskiness of specific borrowers;

■ Adding a residual-income test to the requirements for an FHA-insured mortgage to better measure borrowers’ ability to repay the loan (as the Department of Veterans Affairs does in its mortgage guarantee program);

■ Reducing the limit on the size of a mortgage that FHA can guarantee;

■ Restricting eligibility for FHA-insured mortgages only to first-time homebuyers and low- to moderate-income borrowers;

■ Requiring some borrowers to receive mortgage counseling to help them better understand their financial obligations; and

■ Providing a grant to help borrowers with their down payment, in exchange for which FHA would receive part of the increase in their home’s value when it was sold.

Although some of those approaches would require action by lawmakers, several of the options could be implemented by FHA without legislation. In addition, certain options could be combined to change the nature of FHA’s risk exposure or the composition of its guarantees. CBO did not examine the results of combining options.

What Effects Would the Policy Options Have?

Making one or more of those policy changes would affect FHA’s financial position, its role in the broader mortgage market, and the federal budget. All of the options would improve the agency’s financial position by reducing its exposure to the risk of losses on the mortgages it insures (see Table 1). The main reason for that reduction would be a decrease in the amount of mortgages guaranteed by FHA. CBO projects that under current law, FHA would insure $220 billion in new single-family mortgages in 2018. The options would lower that amount by anywhere from $15 billion to $77 billion (see Figure 1). Some options would also reduce FHA’s risk exposure by decreasing insurance losses as a percentage of the value of the guaranteed mortgages. (1-2)

Community Bankers and GSE Reform

The Independent Community Bankers of America have release ICBA Principles for GSE Reform and a Way Forward. Although this paper is not as well thought-out as that of the Mortgage Bankers Association, it is worth a look in order to understand what drives community bankers.

The paper states that the smaller community banks

depend on the GSEs for direct access to the secondary market without having to sell their loans through a larger financial institution that competes with them. The GSEs help support the community bank business model of good local service by allowing them to retain the servicing on the loans they sell, which helps keep delinquencies and foreclosures low. And unlike other private investors or aggregators, the GSEs have a mandate to serve all markets at all times. This they have done, in contrast to some private investors and aggregators that severely curtailed their business in smaller and economically distressed markets, leaving those community bank sellers to find other outlets for their loan sales. (1)

The ICBA sets forth a set of principles to guide GSE reform, including

  • The GSEs must be allowed to rebuild their capital buffers.
  • Lenders should have competitive, equal, direct access on a single-
    loan basis.
  • Capital, liquidity, and reliability are essential.
  • Credit risk transfers must meet targeted economic returns.
  • An explicit government guarantee on GSE MBS is needed.
  • The TBA market for GSE MBS must be preserved.
  • Strong oversight from a single regulator will promote sound operation.
  • Originators must have the option to retain servicing, and servicing fees must be reasonable.
  • Complexity should not force consolidation.
  • GSE assets must not be sold or transferred to the private market.
  • The purpose and activities of the GSEs should be appropriately limited.
  • GSE shareholder rights must be upheld.

This paper does not really provide a path forward for GSE reform, but it does clearly state the needs of community bankers. That is valuable in itself. There is also a lot of common sense behind the principles they espouse. But it is a pretty conservative document, working from the premise that the current system is pretty good so if it ain’t broke, why fix it? I think other stakeholders believe the system is way more broke than community bankers believe it to be.

There are also some puzzlers in it this paper. Why the focus on GSE shareholder rights? Is it because many community banks held GSE stock before the financial crisis? Are there other reasons that this is one of their main principles?

Hopefully, over time community bankers will flesh out the thinking that went into this paper in order to fuel an informed debate on the future of the housing finance market.

 

 

The Housing Market Under Trump

photo by http://401kcalculator.org

TheStreet.com quoted me in Interest Rates Likely to Rise Under Trump, Could Affect Confidence of Homebuyers. It opens,

Interest rates should increase gradually during the next four years under a Donald Trump administration, which could dampen growth in the housing industry, economists and housing experts predict.

The 10-year Treasury rose over the 2% threshold on Wednesday for the first time in several months, driving mortgage rates higher with the 30-year conventional rate rising to 3.73% according to Bankrate.com. Mortgage pricing is tied to the 10-year Treasury.

Housing demand will remain flat with a rise in interest rates as many first-time homebuyers will be saddled with more debt, said Peter Nigro, a finance professor at Bryant University in Smithfield, R.I.

“With first-time homebuyers more in debt due to student loans, I don’t expect much growth in home purchasing,” he said.

Interest rates will also be affected by the size of the fiscal stimulus since additional infrastructure spending and associated debt “could push interest rates up through the issuance of more government debt,” Nigro said.

Even if interest rates spike in the next year, banks will not benefit, because there is a lack of demand, said Peter Borish, chief strategist with Quad Group, a New York-based financial firm. The economy is slowing down, and consumers have already borrowed money at very “cheap” interest rates, he said.

The policies set forth by a Trump administration will lead to contractionary results and will not spur additional growth in the housing market.

“I prefer to listen to the markets,” Borish said. “This will put downward pressure on the prices in the market. Everyone complained about Dodd-Frank, but why is JPMorgan Chase’s stock at all time highs?”

An interest rate increase could still occur in December, said Jonathan Smoke, chief economist for Realtor.com, a Santa Clara, Calif.-based real estate company. With nearly five weeks before the December Federal Open Market Committee (FOMC) meeting, the market can contemplate the potential outcomes.

“While the market is now indicating a reduced probability of a short-term rate hike at that meeting, the Fed has repeatedly indicated that they would be data-driven in their decision,” he said in a written statement. “If the markets calm down and November employment data look solid on December 2, a rate hike could still happen. The market moves yesterday are already indicating that financial markets are pondering that the Trump effect could be positive for the economy.

“The Fed is likely to start increasing the federal funds rate at a “much faster pace starting next year,” said K.C. Sanjay, chief economist for Axiometrics, a Dallas-based apartment market and student housing research firm. “This will cause single-family mortgage rates to increase slightly, however they will remain well below the long-term average.”

Since Trump has remained mum on many topics, including housing, predicting a short-term outlook is challenging. One key factor is the future of Fannie Mae and Freddie Mac, who are the main players in the mortgage market, because they own or guarantee over $4 trillion in mortgages, remain in conservatorship and “play a critical role in keeping mortgage rates down through the now explicit subsidy or government backing which allows them to raise funds more cheaply,” Nigro said.

It is unlikely any changes will occur with them, because “Trump has not articulated a plan to deal with them and coming up with a plan to deal with these giants is unlikely,” he said.

Trump could attempt to take on government sponsored enterprises such as Fannie Mae and Freddie Mac, said Ralph McLaughlin, chief economist for Trulia, a San Francisco-based real estate website.

“If he does, it’s going to be a hairy endeavor for him, because he’ll need bipartisan support to do so,” he said.

Since he has alluded to ending government conservatorship and allowing government sponsored enterprises to “recapitalize by allowing retention of their own profits instead of passing them on to the Treasury,” the result is that banks could have their liquidity and lending activity increase, which could help boost demand for homes, McLaughlin said.

“We caution President-elect Trump that he would also need to simultaneously help address housing supply, which has been at a low point over the past few years,” he said. “The difficulty for him is that most of the impediments to new housing supply rest and the state and local levels, not the federal.”

Even on Trump’s campaign website, there is “next to nothing” about his ideas on housing, said David Reiss, a law professor at the Brooklyn Law School in New York. The platform of the Republican Party and Vice President-elect Mike Pence could mean that the federal government will have a smaller footprint in the mortgage market.

“There will be a reduction in the federal government’s guaranty of mortgages, and this will likely increase the interest rates charged on mortgages, but will reduce the likelihood of taxpayer bailouts,” he said. “Fannie and Freddie will likely have fewer ties to the federal government and the FHA is likely to be limited to the lower end of the mortgage market.”

The Republican Housing Platform

photo by DonkeyHotey

The Republican Party adopted its platform earlier this week.  The short housing platform is worth reading in its entirety:

Responsible Homeownership and Rental Opportunities

Homeownership expands personal liberty, builds communities, and helps Americans create wealth. “The American Dream” is not a stale slogan. It is the lived reality that expresses the aspirations of all our people. It means a decent place to live, a safe place to raise kids, a welcoming place to retire. It bespeaks the quiet pride of those who work hard to shelter their family and, in the process, create caring neighborhoods.

The Great Recession devastated the housing market. U.S. taxpayers paid billions to rescue Freddie Mac and Fannie Mae, the latter managed and controlled by senior officials from the Carter and Clinton Administrations, and to cover the losses of the poorly-managed Federal Housing Administration. Millions lost their homes, millions more lost value in their homes.

More than six million households had to move from homeownership to renting. Rental costs escalated so that today nearly 12 million families spend more than 50 percent of their incomes just on rent. The national homeownership rate has sharply fallen and the rate for minority households and young adults has plummeted. So many remain unemployed or underemployed, and for the lucky ones with jobs, rising rents make it harder to save for a mortgage.

There is a growing sense that our national standard of living will never be as high as it was in the past. We understand that pessimism but do not share it, for we believe that sound public policies can restore growth to our economy, vigor to the housing market, and hope to those who are now on the margins of prosperity.

Our goal is to advance responsible homeownership while guarding against the abuses that led to the housing collapse. We must scale back the federal role in the housing market, promote responsibility on the part of borrowers and lenders, and avoid future taxpayer bailouts. Reforms should provide clear and prudent underwriting standards and guidelines on predatory lending and acceptable lending practices. Compliance with regulatory standards should constitute a legal safe harbor to guard against opportunistic litigation by trial lawyers.

We call for a comprehensive review of federal regulations, especially those dealing with the environment, that make it harder and more costly for Americans to rent, buy, or sell homes.

For nine years, Fannie Mae and Freddie Mac have been in conservatorship and the current Administration and Democrats have prevented any effort to reform them. Their corrupt business model lets shareholders and executives reap huge profits while the taxpayers cover all loses. The utility of both agencies should be reconsidered as a Republican administration clears away the jumble of subsidies and controls that complicate and distort home-buying.

The Federal Housing Administration, which provides taxpayer-backed guarantees in the mortgage market, should no longer support high-income individuals, and the public should not be financially exposed by risks taken by FHA officials. We will end the government mandates that required Fannie Mae, Freddie Mac, and federally-insured banks to satisfy lending quotas to specific groups. Discrimination should have no place in the mortgage industry.

Zoning decisions have always been, and must remain, under local control. The current Administration is trying to seize control of the zoning process through its Affirmatively Furthering Fair Housing regulation. It threatens to undermine zoning laws in order to socially engineer every community in the country. While the federal government has a legitimate role in enforcing non-discrimination laws, this regulation has nothing to do with proven or alleged discrimination and everything to do with hostility to the self-government of citizens. (4)

Here are some of the policy proposals that I think it gets right: abolishing Fannie and Freddie in their current form as hybrid public/private corporations; implementing regulation that promotes responsible underwriting and protects against predatory lending; and banning discrimination in the credit markets.

There is a lot of coded language in the platform, however. And that coded language may be inconsistent with some of those goals. For instance, the opposition to the Obama Administration’s attempts to reduce de facto segregation in the housing markets through such initiatives as the Affirmatively Furthering Fair Housing regulation undercuts the claim that the party opposes discrimination in the housing market.

It will be a long, strange trip to the November election. The direction of federal housing policy must be counted as one of important issues at stake.

Spreading Mortgage Credit Risk

photo by A Syn

The Federal Housing Finance Agency has released the Single-Family Credit Risk Transfer Progress Report. Important aspects of Fannie and Freddie’s future are described in this report. It opens,

Since 2012, the Federal Housing Finance Agency (FHFA) has set as a strategic objective that Fannie Mae and Freddie Mac share credit risk with private investors. While the Enterprises have a longstanding practice of sharing credit risk on certain loans with primary mortgage insurers and other counterparties, the credit risk transfer transactions have taken further steps to share credit risk with private market participants. Since the Enterprises were placed in conservatorship in 2008, they have received financial support from the U.S. Department of the Treasury under the Senior Preferred Stock Purchase Agreements (PSPAs). The Enterprises’ credit risk transfer programs reduce the overall risk to taxpayers under these agreements.

These programs have made significant progress since they were launched in 2012 and credit risk transfer transactions are now a regular part of the Enterprises’ businesses. This progress is reflected in FHFA’s 2016 Scorecard for Fannie Mae, Freddie Mac, and Common Securitization Solutions (2016 Scorecard), which sets the expectation that the Enterprises will transfer risk on 90 percent of targeted single-family, 30-year, fixed-rate mortgages. FHFA works with the Enterprises to ensure that credit risk transfer transactions are conducted in an economically sensible way that effectively transfers risk to private investors.

This Progress Report provides an overview of how the Enterprises share credit risk with the private sector, including through primary mortgage insurance and the Enterprises’ credit risk transfer programs. The discussion includes year-end 2015 data, a discussion of which Enterprise loan acquisitions are targeted for the credit risk transfer programs, and an overview of investor participation information. (1, footnotes omitted)

This push to share credit risk with private investors is a significant departure from the old Fannie/Freddie business model and it should do just what it promises: reduce taxpayer exposure to credit risk for the trillions of dollars of mortgages the two companies guarantee through their mortgage-backed securities. That being said, this is a relatively new initiative and the two companies (and the FHFA, as their conservator and regulator) have to navigate a lot of operational issues to ensure that this transfer of credit risk is priced appropriately.

There are also some important policy issues that have not been settled. The FHFA has asked for feedback on a series of issues in its Single-Family Credit Risk Transfer Request for Input, including,

  • how to “develop a deeper mortgage insurance structure” (RfI, 17)
  • how to develop credit risk transfer strategies that work for small lenders (RfI, 18)
  • how to price the fees that Fannie and Freddie charge to guarantee mortgage-backed securities (RfI, 19)

Congress has abdicated its responsibility to implement housing finance reform, so it is left up to the FHFA to make it happen. Indeed, the FHFA’s timeline has this process being finalized in 2018. The only way for the public to affect the course of reform is through the type of input the FHFA is now seeking:

FHFA invites interested parties to provide written input on the questions listed [within the Request for Input] 60 days of the publication of this document, no later than August 29, 2016. FHFA also invites additional input on the topics discussed in this document that are not directly responsive to these questions.

Input may be submitted electronically using this response form. You may also want to review the FHFA’s update on Implementation of the Single Security and the Common Securitization Platform and its credit risk transfer page as it has links to other relevant documents.