Tag Archives: housing finance

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.

The FHA and African-American Homeownership

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Federal Government Redlining Map from 1936

I have posted my article, The Federal Housing Administration and African-American Homeownership, to SSRN and BePress. The abstract reads,

The United States Federal Housing Administration (“FHA”) has been a versatile tool of government since it was created during the Great Depression. It achieved success with some of its goals and had a terrible record with others. Its impact on African-American households falls, in many ways, into the latter category.  The FHA began redlining African-American communities at its very beginning.  Its later days have been marred by high default and foreclosure rates in those same communities.

 At the same time, the FHA’s overall impact on the housing market has been immense.  Over its lifetime, it has insured more than 40 million mortgages, helping to make home ownership available to a broad swath of American households. And indeed, the FHA mortgage was central to America’s transformation from a nation of renters to homeowners. The early FHA really created the modern American housing finance system, as well as the look and feel of postwar suburban communities.

 Recently, the FHA has come under attack for the poor execution of some of its policies to expand homeownership, particularly minority homeownership. Leading commentators have called for the federal government to stop employing the FHA to do anything other than provide liquidity to the low end of the mortgage market.  These critics’ arguments rely on a couple of examples of programs that were clearly failures, but they fail to address the FHA’s long history of undertaking comparable initiatives. This Article takes the long view and demonstrates that the FHA has a history of successfully undertaking new homeownership programs.  At the same time, the Article identifies flaws in the FHA model that should be addressed in order to prevent them from occurring if the FHA were to undertake similar initiatives to expand homeownership opportunities in the future, particularly for African-American households.

Three Paths to Housing Finance Reform

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photo by theilr

The Urban Institute’s Jim Parrott has posted Clarifying the Choices in Housing Finance Reform. It opens,

The housing finance reform debate has often foundered under the weight of its complexity. Not only is it a complicated topic, both in its substance and its politics, but the way that we talk about it makes the issues involved indecipherable to all but a few. Each proponent brings a different nomenclature, a different frame of reference, often an entirely different language, making it enormously difficult to sort through where there is agreement and where there is not.

As a case in point, three prominent proposals for reform have been put on the table in recent months: one offered by Lew Ranieri, Gene Sperling, Mark Zandi, Barry Zigas, and me (Promising Road Proposal); one offered by Ed DeMarco and Michael Bright (Milken Proposal); and one offered by the Mortgage Bankers Association (MBA Proposal). These proposals have been discussed and debated in many forums, each assessed for its respective merits, risks, and likelihood of passage in Congress, but each largely in isolation from one another. That is, they are not compared in any intelligible way, forcing those hoping to come to an informed view to choose among what appear to be entirely different visions of reform, without any easy way to make sense of the choice.

In this brief essay, I thus bring these three proposals together into a single framework, making it clearer what they share and where they differ. Once the explanatory fog is lifted, one can see that they actually share a great deal and that deciding among them is not prohibitively complex, but a matter of assessing two or three key differences. (1-2)

After a review of each proposal, Parrott finds that there are two critical differences between the three proposals.

  • Ginnie versus CSP. For the securitization infrastructure in the new system, Milken uses the Ginnie Mae infrastructure, while the MBA and our proposal both use the CSP.
  • What to do with Fannie and Freddie. The MBA would turn them into privately owned utilities that compete with other market participants over the distribution of the system’s non-catastrophic credit risk, Milken would turn them into lender-owned mutuals that do the same, and we would combine them with the CSP to distribute that risk and manage the system’s securitization.

With these distinctions in mind, the proposals can be much more easily compared across the criteria that should ultimately drive our decisions on housing finance reform:

  • Access to sustainable credit. Which best maintains broad access to mortgage loans for those in a financial position to be a homeowner at the lowest rates?
  • Protecting the taxpayer. Which best insulates taxpayers behind private capital, aligns incentives systemwide and addresses the too-big-to-fail risk that undermined the prior system?
  • Promoting healthy competition. Which best maximizes the kinds of competition that will improve options and services for consumers, lenders, and investors?
  • Ease of transition. Which provides the least disruptive, least costly path of reform? (7-8)

This is a very useful tool for understanding the choices that we face if we are to move beyond the limbo of Fannie and Freddie’s conservatorships.  One limitation is that Parrott does not address the Hensarling wing of the Republican Party which is looking to completely privatize the housing finance system for conforming mortgages. Given that Hensarling is the Chair of the House Financial Services Committee, he will have a powerful role in enacting any reform legislation.

I am not all that hopeful that Congress will be able to come up with a bill that can pass both houses in the near future.  But Parrott’s roadmap is helpful preparation for when we are ready.

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.

Housing Booms and Busts

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photo by Alex Brogan

Patricia McCoy and Susan Wachter have posted Why Cyclicality Matter to Access to Mortgage Credit to SSRN. The paper is now particularly relevant because of President Trump’s plan to roll back Dodd-Frank’s regulation of the financial markets, including the mortgage market. While McCoy and Wachter do not claim that Dodd-Frank solves the problem of cyclicality in the mortgage market, they do highlight how it reduces some of the worst excesses in that market. They make a persuasive case that more work needs to be done to reduce mortgage market cyclicality.

The abstract reads,

Virtually no attention has been paid to the problem of cyclicality in debates over access to mortgage credit, despite its importance as a driver of tight credit. Housing markets are prone to booms accompanied by bubbles in mortgage credit in which lenders cut underwriting standards, leading to elevated loan defaults. During downturns, these cycles artificially impede access to mortgage credit for underserved communities. During upswings, these cycles make homeownership unnecessarily precarious for many who attain it. This volatility exacerbates wealth and income disparities by ethnicity and race.

The boom-bust cycle must be addressed in order to assure healthy and sustainable access to credit for creditworthy borrowers. While the inherent cyclicality of the housing finance market cannot be fully eliminated, it can be mitigated to some extent. Mitigation is possible because housing market cycles are financed by and fueled by debt. Policymakers have begun to develop a suite of countercyclical tools to help iron out the peaks and troughs of the residential mortgage market. In this article, we discuss why access to credit is intrinsically linked to cyclicality and canvass possible techniques to modulate the extremes in those cycles.

McCoy and Wachter’s conclusions are worth heeding:

If homeownership is to attain solid footing, mitigating the cyclicality in the housing finance system will be imperative. That will require rooting out procyclical practices and requirements that fuel booms and busts. In their place, countercyclical measures must be instituted to modulate the highs and lows in the lending cycle. In the process, the goal is not to maximize homeownership per se; rather, it is to ensure that residential mortgages are made on safe and affordable terms.

*     *     *

Taming procyclicality in industry practices in housing finance is much farther behind and will require significantly more work. There is no easy fix for the procyclical effect of mortgage appraisals because appraisals are based on neighboring comparables. Similarly, procyclicality will require serious attention if the private-label securitization market returns. While the Dodd-Frank Act made modest reforms designed at curbing inflation of credit ratings, the issuer-pays system that drives grade inflation remains in place. Similarly, underpricing the risk of MBS and CDS will continue to be a problem in the absence of an effective short-selling mechanism and the effective identification of market-wide leverage. (34-35)

McCoy and Wachter offer a thoughtful overview of the risks that mortgage market cyclicality poses, but I am not optimistic that it will get a hearing in today’s Washington.  Maybe it will after the next bust.

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.

Can Fannie and Freddie Be Privatized?

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Kroll Bond Rating Agency posted Housing Reform 2017: Can the GSEs be Privatized? The big housing finance reform question is whether there is now sufficient consensus in Washington to determine the fate of Fannie and Freddie, now approaching their ninth year in conservatorship.

Kroll concludes,

The Mortgage Bankers Association sends a very clear message about privatizing the GSEs: It will raise rates for homeowners and add systemic risk back into the financial system. Why do we need to fix a proven market mechanism that is not broken? KBRA believes that if Mr. Mnuchin and the President-elect truly want to encourage the growth of a private market for U.S. mortgages, then they must accept that true privatization of the GSEs that eliminates any government guarantee would fundamentally change the mortgage market.

The privatization of the GSEs implies, in the short term at least, a significant decrease in the financing available to the U.S. housing market. In the absence of a TBA market, no coupon would be high enough to support the entire range of demand for mortgage finance, only pockets of higher quality loans as with the jumbo mortgage market today. Unless the U.S. moved to the Danish model with 100% variable rate notes, no nonbank could fund the production of home mortgages efficiently and commercial banks are unlikely to pick up the slack for the reasons discussed above.

In the event of full privatization of the GSEs, private loans will have significantly higher cost for consumers and offer equally more attractive returns for financial institutions and end investors, a result that would generate enormous political opposition among the numerous constituencies in the housing market. Needless to say, getting such a proposal through Congress should prove to be quite an achievement indeed. (4)

I disagree with Kroll’s framing of the issue:  “Why do we need to fix a proven market mechanism that is not broken?” To describe Fannie and Freddie as “not broken” seems farcical to me. They are in a state of limbo with extraordinary backing from the federal government. It might be that we would want to continue them with much the same functionality that they currently have, but we would still want this transition to be done intentionally.  Nobody, but nobody, was thinking that putting them into conservatorship was the end game,

While the current structure has some advantages over privatization, the reverse is true too.  The greatest benefit of privatization is getting rid of the taxpayer backstop in case of a failure by one or both of the companies.

We shouldn’t be saying — hey, what we have now is good enough. Rather, we should be asking — what do we expect out of our housing finance system and how do we get it?

There appears to be a broad consensus to reduce taxpayer exposure to a bailout.  There also appears to be a broad consensus (one that I do not support as broadly as others) to protect the 30 year fixed rate mortgage that remains so popular in the United States.

Industry insiders believe that a fully private system would not provide sufficient capital for the mortgage market. They are also concerned that a fully private system would put the kibosh on the To Be Announced (TBA) market that provides so much stability for the mortgage origination process.

A thoughtful reform proposal could incorporate all of these concerns while also clearing away the sticky problems built into the Fannie/Freddie model of housing finance.

“If it ain’t broke don’t fix it” is not a good enough philosophy after we have lived through the financial crisis. We should focus on the big questions of what we want from our 21st century housing finance system and then design a system that will implement it accordingly.