Tag Archives: private sector

Planning for a Wetter Future

Posted on by

 

picture by Charly W. Karl

Enterprise has issued Safer and Stronger Cities: Strategies for Advocating for Federal Resilience Policy. The report

offers a menu of federal recommendations organized into five chapters focusing on infrastructure, housing, economic development and public safety. Each chapter includes a set of strategies, background on the issue, explanations of the role of the Federal Government, listing of potential allies in advocating for the recommendations, and relevant examples of current or previous local, state, and federal actions.

To better support city resilience, these recommendations include high level proposals for cities to coordinate with federal government for both legislative and agency actions, which cities can drive forward. Policy and program changes will increase or leverage investment from the private sector are highlighted. (2)

The report recommends, among other things, that the federal government should

  1. Create a National Infrastructure Bank that supports private-public investments in resilient infrastructure, including retrofits.
  2. Align cost-benefit analyses across federal agencies and require agencies to consider the full life cycle costs and benefits of infrastructure over the asset’s design life and in consideration of future conditions.
  3. Cultivate partnerships between cities and the Defense Department to promote resilience of city assets that are critical to national security and military installations.
  4. Implement a system that scores infrastructure based on its resilience to better prioritize scarce federal funds.
  5. Coordinate Federal Government grant-making and permitting related to hazard mitigation and disaster recovery. (10)

These are good proposals, no question about it. I am not too optimistic that the current leadership in Washington will heed any of them. Local partnerships with the Defense Department might have some legs in today’s environment though, particularly given recent news reports about foreign hacking into the electrical grid.

Even those who discount the global risks arising from climate change should acknowledge the need to bolster the resiliency of our coastal cities. Let’s hope we start planning for a wetter future sooner rather than later.

De Facto Housing Finance Reform

Posted on by

photo by The Tire Zoo

David Finkelstein, Andreas Strzodka and James Vickery of the NY Fed have posted Credit Risk Transfer and De Facto GSE Reform. It opens,

Nearly a decade into the conservatorships of Fannie Mae and Freddie Mac, no legislation has yet been passed to reform the housing finance system and resolve the long-term future of these two government-sponsored enterprises (GSEs). The GSEs have, however, implemented significant changes to their operations and practices over this period, even in the absence of legislation. The goal of this paper is to summarize and evaluate one of the most important of these initiatives – the use of credit risk transfer (CRT) instruments to shift mortgage credit risk from the GSEs to the private sector.

Fannie Mae and Freddie Mac have significant mortgage credit risk exposure, largely because they provide a credit guarantee to investors on the agency mortgage-backed securities (MBS) they issue. Since the CRT programs began in 2013, Fannie Mae and Freddie Mac have transferred to the private sector a portion of the credit risk on approximately $1.8 trillion in single-family mortgages (as of December 2017; source: Fannie Mae, 2017, Freddie Mac, 2017). The GSEs have experimented with a range of different risk transfer instruments, including reinsurance, senior-subordinate securitizations, and transactions involving explicit lender risk sharing. The bulk of CRT, however, has occurred via the issuance of structured debt securities whose principal payments are tied to the credit performance of a reference pool of securitized mortgages. A period of elevated mortgage defaults and losses will  trigger automatic principal write-downs on these CRT bonds, partially offsetting credit losses experienced by the GSEs.

Our thesis is that the CRT initiative has improved the stability of the  housing finance system and advanced a number of important objectives of GSE reform. In particular the CRT programs have meaningfully reduced the exposure of the Federal government to mortgage credit risk without disrupting the liquidity or stability of secondary mortgage markets. In the process, the CRT programs have created a new financial market for pricing and trading mortgage credit risk, which has grown in size and liquidity over time. Given diminished private-label securitization activity in recent years, these CRT securities are one of the primary ways for private-sector capital market investors to gain exposure to residential mortgage credit risk.

An important reason for this success is that the credit risk transfer programs do not disrupt the operation of the agency MBS market or affect the risks facing agency MBS investors. Because agency MBS carry a GSE credit guarantee, agency MBS investors assume that they are exposed to interest rate risk and prepayment risk, but not credit risk. This reduces the set of parameters on which pass-through MBS pools differ from one another, improving the standardization of the securities underlying the liquid to-be-announced (TBA) market where agency MBS mainly trade. Even though the GSEs now use CRT structures to transfer credit risk to a variety of private sector investors, these arrangements do not affect agency MBS investors, since the agency MBS credit guarantee is still being provided only by the GSE. In other words, the GSE stands in between the agency MBS investors and private-sector CRT investors, acting in a role akin to a central counterparty.

Ensuring that Fannie Mae and Freddie Mac’s credit risk sharing efforts occur independently of the agency MBS market is important for both market functioning and financial stability. The agency MBS market, which remains one of the most liquid fixed income markets in the world, proved to be quite resilient during the 2007-2009 financial crisis, helping to support the supply of mortgage credit during that period. The agency market financed $2.89 trillion of mortgage originations during 2008 and 2009, experiencing little drop in secondary market trading volume during that period. In contrast, the non-agency MBS market, where MBS investors are exposed directly to credit risk, proved to be much less stable; Issuance in this market essentially froze in the second half of 2007, and has remained at low levels since that time.4 (1-2, citations and footnotes omitted)

One open question, of course, is whether the risk transfer has been properly priced. We won’t be able to fully answer that question until the next crisis tests these CRT securities. But in the meantime, we can contemplate the authors’ conclusion:

the CRT program represents a valuable step forward towards GSE
reform, as well as a basis for future reform. Many proposals have been put forward for long-term reform of mortgage market since the GSE conservatorships began in 2008. Although the details of these proposals vary, they generally share in common the goals of

(1) ensuring that mortgage credit risk is borne by the private sector (probably with some form of government backstop and/or tail insurance to insure catastrophic risk and stabilize the market during periods of stress), while

(2) maintaining the current securitization infrastructure as well as the standardization and liquidity of agency MBS markets.

The credit risk transfer program, now into its fifth year, represents an effective mechanism for achieving these twin goals. (21, footnote omitted)

Trump, Homelessness and the General Welfare

Posted on by

photo by Jay Black

The Hill published my column, Trump’s Budget Proposal Is Bad News for Housing Across the Nation. It opens,

The White House unveiled its much anticipated budget proposal today. It shows deep cuts to important agencies, including a more than $6 billion decrease in funding to the U.S Department of Housing and Urban Development (HUD). More than 75 percent of the agency’s budget goes to helping families pay their rent. Thus, these cuts would have a negative impact on thousands upon thousands of poor and working class households.

Many years ago, Congress enshrined the “goal of a decent home and a suitable living environment for every American family” within its Declaration of National Housing Policy. This goal was not just justified by the basic needs of those with inadequate housing, but also because “the general welfare and security of the nation” required it. As our nation’s leading cities grapple with rapidly growing homeless populations, this additional justification takes on added weight today.

Click here to read the rest of it.

Taking up Housing Finance Reform

Posted on by

photo by Elliot P.

I am going to be a regular contributor to The Hill, the political website.  Here is my first column, It’s Time to Take Housing Finance Reform Through The 21st Century:

Fannie Mae and Freddie Mac, the two mortgage giants under the control of the federal government, have more than 45 percent of the share of the $10 trillion of mortgage debt outstanding. Ginnie Mae, a government agency that securitizes Federal Housing Administration (FHA) and Veterans Affairs (VA) mortgages, has another 16 percent.

These three entities together have a 98 percent share of the market for new residential mortgage-backed securities. This government domination of the mortgage market is not tenable and is, in fact, dangerous to the long-term health of the housing market, not to mention the federal budget.

No one ever intended for the federal government to be the primary supplier of mortgage credit. This places a lot of credit risk in the government’s lap. If things go south, taxpayers will be on the hook for another big bailout.

It is time to implement a housing finance reform plan that will last through the 21st century, one that appropriately allocates risk away from taxpayers, ensures liquidity during crises, and provides access to the housing markets to those who can consistently make their monthly mortgage payments.

The stakes for housing finance reform today are as high as they were in the 1930s when the housing market was in its greatest distress. It seems, however, that there was a greater clarity of purpose back then as to how the housing markets should function. There was a broadly held view that the government should encourage sustainable homeownership for a broad swath of households and the FHA and other government entities did just that.

But the Obama Administration and Congress have not been able to find a path through their fundamental policy disputes about the appropriate role of Fannie and Freddie in the housing market. The center of gravity of that debate has shifted, however, since the election. While President-elect Donald Trump has not made his views on housing finance reform broadly known, it is likely that meaningful reform will have a chance in 2017.

Even if reform is more likely now, just about everything is contested when it comes to Fannie and Freddie. Coming to a compromise on responses to three types of market failures could, however, lead the way to a reform plan that could actually get enacted.

Even way before the financial crisis, housing policy analysts bemoaned the fact that Fannie and Freddie’s business model “privatizing gains and socialized losses.” The financial crisis confirmed that judgment. Some, including House Financial Services Committee Chairman Jeb Hensarling (R-Texas), have concluded that the only way to address this failing is to completely remove the federal government from housing finance (allowing, however, a limited role for the FHA).

The virtue of Hensarling’s Protecting American Taxpayers and Homeowners Act (PATH) Act of 2013 is that it allocates credit risk to the private sector, where it belongs. Generally, government should not intervene in the mortgage markets unless there is a market failure, some inefficient allocation of credit.

But the PATH Act fails to grapple with the fact that the private sector does not appear to have the capacity to handle all of that risk, particularly on the terms that Americans have come to expect. This lack of capacity is a form of market failure. The ever-popular 30-year fixed-rate mortgage, for instance, would almost certainly become an expensive niche product without government involvement in the mortgage market.

The bipartisan Housing Finance Reform and Taxpayer Protection Act of 2014, or the Johnson-Crapo bill, reflects a more realistic view of how the secondary mortgage market functions. It would phase out Fannie and Freddie and replace it with a government-owned company that would provide the infrastructure for securitization. This alternative would also leave credit risk in the hands of the private sector, but just to the extent that it could be appropriately absorbed.

Whether we admit it or not, we all know that the federal government will step in if a crisis in the mortgage market gets bad enough. This makes sense because frozen credit markets are a type of market failure. It is best to set up the appropriate infrastructure now to deal with such a possibility, instead of relying on the gun-to-the-head approach that led to the Fannie and Freddie bailout legislation in 2008.

Republicans and Democrats alike have placed homeownership at the center of their housing policy platforms for a long time. Homeownership represents stability, independence and engagement with community. It is also a path to financial security and wealth accumulation for many.

In the past, housing policy has overemphasized the importance of access to credit. This has led to poor mortgage underwriting. When the private sector also engaged in loose underwriting, we got into really big trouble. Federal housing policy should emphasize access to sustainable credit.

A reform plan should ensure that those who are likely to make their mortgage payment month-in, month-out can access the mortgage markets. If such borrowers are not able to access the mortgage market, it is appropriate for the federal government to correct that market failure as well. The FHA is the natural candidate to take the lead on this.

Housing finance reform went nowhere over the last eight years, so we should not assume it will have an easy time of it in 2017. But if we develop a reform agenda that is designed to correct predictable market failures, we can build a housing finance system that supports a healthy housing market for the rest of the century, and perhaps beyond.

GSE Reform, by Stealth?

Posted on by

Photo By Greg Willis

The Urban Institute’s Housing Finance Policy Center has issued its January 2016 Housing Finance at a Glance Chartbook. It opens by noting,

The FHFA recently released its 2016 Scorecard for Fannie Mae and Freddie Mac with updated guidance for credit risk transfer transactions. A year ago, under the 2015 scorecard, the FHFA had required Fannie Mae and Freddie Mac to transfer credit risk on a fixed dollar amount of UPB [unpaid principal balance] – $150 billion for Fannie Mae and $120 billion for Freddie Mac. Both exceeded those targets (Fannie $187 billion and Freddie 210 billion). Additionally, the 2015 scorecard did not indicate how much credit risk should be transferred (expected or unexpected, or a specific numeric threshold for example), instead leaving it to the GSEs’ discretion.
But that changes in 2016. FHFA’s 2016 scorecard is a notable departure from 2015 in that it requires the GSEs to transfer credit risk on “at least 90 percent” of the newly acquired UPB (with exceptions for HARP refinances, mortgages with maturities 20 years and below and with loan-to-value ratios 60 percent and below). Another departure from 2015 is the added requirement to transfer a substantial portion of credit risk covering “most of the credit losses projected to occur during stressful economic scenarios.” In other words, GSEs are required to transfer nearly all credit risk on new production, except for what is catastrophic. These two requirements are highly noteworthy because over time they will put the GSEs (and hence the taxpayers) in a remote, catastrophic risk position, letting private capital bear vast majority of credit losses the vast majority of the time – a key objective of most housing finance reform proposals. (3)
I have been arguing for a long time that the private sector should bear the credit risk in the mortgage market, so I think this is a good thing in principle. The FHFA needs to ensure, of course, that the agencies are pricing the transfer of credit risk properly, but overall this is a step in the right direction. Not being privy to any conversations in the Beltway, I always wonder if things like this happen with some kind of bipartisan acquiescence, but I guess we won’t know until someone tells us what happened behind closed doors.

The End of Private-Label Securities?

Posted on by
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.

Reforming Fannie & Freddie’s Multifamily Business

Posted on by

Mark Willis & Andrew Neidhardt’s article, Reforming the National Housing Finance System: What’s at Risk for the Multifamily Rental Market if Fannie Mae and Freddie Mac Go Away?, was recently published in a special issue of the NYU Journal of Law & Business. Most of the ink spilled about the reform of Fannie and Freddie addresses their single-family lines of business. The single-family business is much bigger, but the multifamily business is also an important part of what they do.

The author’s conclude that

Reform of the nation’s housing finance system needs to be careful not to disrupt unnecessarily the existing multifamily housing market. The near collapse of Fannie and Freddie’s single-family business over five years ago resulted in conservatorship and has spawned calls for their termination. While a general consensus has since emerged that Fannie and Freddie should be phased out over time, no consensus exists as to which, if any, of their functions need to be replaced in order to preserve the affordability and availability of housing in general, and multifamily rentals in particular.

On the multifamily side, Fannie and Freddie have built specialized units using financing models that involve private sector risk-sharing (i.e., DUS lender capital at risk or investors holding subordinate tranches of K-series securities) and that have resulted in low default rates and limited credit losses. These units have benefited from an implicit government guarantee of their corporate debt, which has expanded their access to capital and lowered its cost. As a result of the implicit guarantee, Fannie and Freddie have been able to: 1) offer longer term mortgages than generally available from banks, 2) provide countercyclical support to the rental market by funding new mortgages throughout the recent housing and economic downturn, and 3) ensure that the vast majority of the mortgages they fund offer rents affordable to households earning less than even 80% of area median income.

The potential for moral hazard can be reduced without disrupting the multifamily housing market simply by separating out and nationalizing the government guarantee It would then be possible to: 1) spin off the multifamily businesses of Fannie and Freddie into self-contained entities and 2) create an explicit government guarantee, offered by a government entity, and paid for through premiums on the insured MBS. The first step could happen now with FHFA authorization. These new subsidiaries could also begin to pay their respective holding companies for providing the guarantee on their MBS. The second step requires Congressional legislation. Once the public guarantor is up and running, the guarantee would be purchased from it and these subsidiaries could then be sold to private investors. As for other reforms that would explicitly restrict market access to the government guarantee, the best approach would be to first test the private sector’s appetite for risk on higher-end deals. (539-40)

This article has a lot to offer in terms of analyzing how Fannie and Freddie’s multifamily business is distinct from their single-family business. But I do not think that it fully makes the case that the multifamily sector suffers from some sort of market failure that requires so much government intervention as it advocates. I suspect that private capital could be put into a first loss position for much more of the lending in this sector. The government could continue to support the low- and moderate-income rental market without being on the hook for the rest of the multifamily market.