Fix the GSEs, don’t end them, Rosner says at Investors Unite
“Too Big to Fail” banks are the new GSEs
Meaningful housing reform is possible in 2014 and doesn’t require Congressional action, renowned housing analyst and author Joshua Rosner told Investors Unite in Washington on Tuesday morning.
Rosner, bestselling author of “Reckless Endangerment” and of the "Most epic Twitter war ever," presented his vision of how to move forward on housing reform and what the consequences are of getting housing reform wrong to the activist group of Fannie Mae and Freddie Mac investors, who have had their rights as shareholders suspended indefinitely.
“There are consequences for lack of reform, or improper reform – the wrong kind of change may make things worse,” Rosner said. “Addressing GSE capital stack issues and reform go hand in hand.”
The panel also hosted a lively discussion on the role of Fannie and Freddie in preserving the dream of American homeownership. The panel, lead by Investors Unite executive director Tim Pagliara, included Rosner, managing director at the independent research consultancy Graham Fisher & Co.; Eva Clayton, former Congress member; Ike Brannon, president of the consulting firm Capital Policy Analytics and Growth Fellow at the George W. Bush Institute; Gary Kalman, executive vice president and director of Federal Policy at the Center for Responsible Lending.
Investors Unite was formed by Pagliara, the chairman and CEO of CapWealth Advisors. Investors Unite opposes any of the GSE reform measures that do not protect the rights of shareholders.
“We believe the rule of law should be followed,” Pagliara said.
In 2008, a conservatorship agreement required that Fannie and Freddie pay the U.S. Treasury a 10% dividend payment to repay the loan that was made. To date, the GSEs have repaid $204 billion dollars to the Treasury, tens of billions in excess of what was originally loaned, but the government refuses to exit its conservatorship.
Since January of 2013, the government has been confiscating 100% of Fannie and Freddie dividends.
Investors Unite believes that replacing Fannie and Freddie with a new, gargantuan federal entity, the Federal Mortgage Insurance Corporation, which would explicitly back mortgages, would add $5 trillion to the taxpayer’s balance sheet and give more control of the mortgage market to the big banks.
Rosner said that strong capital requirements can and should be fixed.
“In the wake of the S&L crisis, as Congress was designing a new regulator and new oversight regime, for the GSEs, Fannie Mae successfully lobbied for and received the weak capital requirements embedded in the 1992 Act,” Rosner said. “How could GSE securities, backed by mortgages, have received the lowest risk weighting when GSE capital standards were lower than other financial firms?”
He also said that the GSEs improperly priced guarantee fees. "In the years between 2003 and 2007, in an effort to retain market share, the GSEs began offering significant discounts on G-fees for large volume customers. Pricing began to diverge from consideration of risk,” Rosner said. “Guarantee fees should reflect underlying, loan-level, mortgage credit risk.”
Rosner argued that the “Too Big to Fail” banks are the new GSEs.
“A GSE is merely a firm that the market believes to have an implied or explicit government guarantee as a result of its size, interconnectedness or charter,” he said. “As a result of Dodd-Frank’s different regime for the existence and resolution of our largest financial firms they, like the GSEs before them, are conferred the lower cost of funds that result from an implied government guarantee.
“As a result, market discipline of these firms is distorted and they have become increasingly able to compete with other firms based on this benefit rather than based on core economic competitiveness,” Rosner said.
Rosner thinks the FHFA has the authority to push forward with meaningful changes. “As a result of HERA, the FHFA has the authority to set capital stronger standards for Fannie and Freddie,” he said. “As a result of the original conservatorship agreement, their has been no defined method for the GSEs to repay the government and no definition of whether repayment would be based on a return of capital or return on capital.”
The GSEs need reduce their portfolios to serve only for liquidity purposes, he argued.
“It is now widely recognized that the use of their portfolios for growth led to a blurring of lines between the GSEs' intended secondary market purpose and the primary mortgage market. This increased the pro-cyclicality of the GSEs and reduced their ability to support the primary market when it failed,” he said. “Congress and FHFA have made meaningful strides toward this end.”
As to Rosner’s opinion of Johnson-Crapo, he offered an analogy. He said to imagine a car getting rear-ended by another car as it is stopped at a stoplight. The damage is significant but repairable. There are two obvious choices, he said.
“Bring the car to an auto repair shop and have it fixed, a rational economic choice with benefits of limited downtime,” he said. “Or junk the car, an uneconomic choice coupled with downtime while raising funds to offset depreciation and buy a new car.”
Rosner said that Johnson-Crapo found a third choice.
“Build a new auto assembly plant to produce a new car,” he said. “Is it an improvement?...The answers are clear, no.”
He said Johnson-Crapo increases the power of our largest banks as both primary market players and with an increasing ability to influence the secondary market, and reduces the ability of smaller banks, that do not benefit from the lower cost of funds that are supported by an implied government guarantee, to compete.
“Real questions remain about the viability of the TBA market under the Crapo-Johnson bill,” he said. “With the GSEs still central to mortgage funding the risks of replacing them with a complex and unproven system increases systemic risks.”
Rosner offered his own plan for fixing the GSEs. Below is a breakdown of the tenets of his plan:
- Suspend the Third Amendment of the conservatorship agreement and allow the GSEs to build capital
- Define repayment of the government’s investment
- Implement strict capital standards
- Eliminate portfolios for other than liquidity purposes
- Use stringent methods to price guarantees, separate from the GSEs and from political influence. This would create incentives for increased private market, unwrapped issuances on which investors would be forced to retain the risk (eliminating the broad government guarantee)
- Regulate the GSEs as utilities with a guarantor of last resort mission
- Create down payment savings plans so that buyers can save for increased down payments and reduce their credit risk and costs of credit
- Replace the mortgage interest deduction with a progressive equity principal tax credit for first time buyers and renters as a means to reduce the need for private players to provide affordable housing goals