The devil is in the mortgage finance reform details
On the bumpy road to a common securitization platform
It now seems all but certain that 2014 will end without any further progress on comprehensive mortgage finance legislation.
But the coming months will offer little comfort for those who rooted for such a stalemate in hope of avoiding hard decisions about fundamental parts of the current system.
Nearly every issue that must be resolved in order to create a more durable housing finance system – and whose resolution confounded congressional staff, members and outside stakeholders -- will now move out of the legislative arena and squarely into the hands of the Federal Housing Finance Agency, the conservator and regulator of Fannie Mae and Freddie Mac.
Comprehensive legislation moved in both the House and Senate during the 113th Congress that will soon end. But the most serious action took place in the Senate Committee on Banking and Urban Affairs.
This work started with the introduction of S. 1217 by Sens. Bob Corker (R-TN) and Mark Warner (D-VA) in 2013, followed by a revised version of that bill sponsored by committee Chair Tim Johnson (D-SD) and Ranking Minority member Mike Crapo (R-ID).
The bill’s evolution highlighted the most contentious issues in housing finance reform – the role and form of private capital in guaranteeing credit risk within a housing finance system that includes a government guarantee; the structure of counterparty relationships and how to adequately oversee a system of private credit guarantees; how to assure that a new structure would adequately serve the broadest credit needs throughout the country; and how to manage the potential for greater consolidation within the mortgage finance industry.
Both Republican and Democratic Senators struggled to reach agreement on these issues, and ultimately failed. (The Urban Institute has published an insightful piece on the process.)
But the issues themselves remain critically important for mortgage finance.
And the FHFA has already launched a series of regulatory initiatives, with more scheduled to follow, that will push past the legislative deadlock and establish new ground rules for Fannie and Freddie. More importantly, FHFA’s resolution of these issues will set in motion changes that will alter the underlying mortgage finance landscape in ways that will be hard to reverse and thus have a significant influence on whatever legislative solution is ultimately adopted.
FHFA already has begun.
Last year it directed Fannie and Freddie to form a jointly owned enterprise to create a common securitization platform (CSP) to replace the companies’ badly outdated technology. FHFA reasoned that having the companies collaborate on a platform that could serve them both, as well as potentially serve other securitizers in the future, would be more cost-effective than leaving both to their own duplicative devices.
Such a common platform was a key feature of S. 1217.
It would have been administered by a new government insurer, the Federal Mortgage Insurance Corporation, the central new body proposed in the bill. Its continuing development under FHFA’s oversight virtually guarantees unstoppable momentum on this feature.One of the logical outcomes of a common securitization platform is a common security, another feature of S. 1217.
FHFA recently solicited comments on a series of questions about developing a single security for Fannie and Freddie under conservatorship.
Many in the mortgage industry are pressing them to forge ahead, pointing to pricing differentials between Fannie and Freddie securities that can distort risk pricing and raise costs for consumers. The further FHFA pushes on this issue, the fewer choices future Congresses will have when undertaking full-scale legislative reform.
Fully serving Americans’ mortgage credit needs is the fundamental reason to have any kind of federal support for the mortgage system in the first place. Assuring that the system under S. 1217 would do so, across the broadest possible range of credit worthy borrowers and in all locales, proved to be the stickiest point of contention in its consideration. ut the failure to reach consensus once again opens the door for FHFA to use its substantial regulatory authority in ways that will greatly influence future legislative designs.
The Johnson-Crapo draft of S. 1217 did significantly improve on earlier versions of the bill by identifying broad service as a key objective.
It incorporated a form of market-driven incentive designed to reduce potentially very high costs for borrowers with lower down payments, or less stellar credit histories by facilitating some cross subsidization across guaranteed portfolios. Democratic members such as Sen. Elizabeth Warren (D-MA) cautiously embraced this approach and struggled to refine it. But they insisted on adding provisions through which FMIC could act in other ways if the incentives turned out not to work as advertised. They were unable to get enough support for this to close a deal.This failure to reach agreement on the details of how to execute on the bill’s stated objective to assure broad access effectively stalled progress on the bill.
FHFA, however, still operates under the directives in the companies’ charters and subsequent legislation in 1992 and 2008 that establish significant service obligations for Fannie and Freddie.
The most obvious of these are the housing goals established in ’92 and revised in ’08. The current goals established by FHFA post-conservatorship expire in 2014. New proposed regulations for the future were issued for comment by FHFA on August 29. The 2008 legislation also added a “duty to serve” obligation beyond the housing goals. Regulations to execute this requirement were proposed in 2010, but never finalized.
Expect FHFA to move these forward shortly.
And the 2008 legislation imposed a 4.2 basis point fee on the annual production of each company to fund the Housing Trust Fund at HUD and Capital Magnet Fund at Treasury. FHFA suspended this assessment in 2009 under acting director Ed DeMarco. But many observers think Director Mel Watt may take a different approach on this than his predecessor.
The previous FHFA leadership viewed the obligation for broad service narrowly, and secondary to other obligations with which they found it to be in tension.
The new leadership at FHFA is expected to view the mix and prioritization of obligations differently. In its Strategic Plan for 2014, the first under Director Watt, FHFA placed access to credit as its highest strategic goal. It also put the brakes on DeMarco’s push to shrink the footprint of the enterprises, removing one of the key barriers to expanding access.
FHFA also recently sought comment on how it should approach regulating the guarantee fees charged by Fannie and Freddie. The fees have increased significantly since conservatorship began. The current outstanding request for comments on how gfees should be calculated is a hugely important step. S. 1217 would have left these decisions to the new FMIC; now the old FHFA will get to execute on them and in doing so set expectations for future structures.
FHFA is moving ahead to reset the GSE table in other areas, as well, particularly in managing counterparty risks. It recently published new, consolidated guidelines for mortgage insurers providing first position credit loss protection for higher loan to value loans guaranteed by Fannie and Freddie.
The new guidelines would require MIs to hold more capital, establish clearer terms for when and how MIs honor their guarantees, and set standards for dealing with nonperforming loans.
FHFA also is examining the GSEs’ relationships with their servicers, and how their guidelines should track with, or go beyond, those established by the Consumer Financial Protection Bureau and other regulators. FHFA also has directed Fannie and Freddie to bring in more private risk-bearing capital through structured re-insurance of their outstanding books in a series of offerings that have found a very receptive market.
All these actions mean that in the near future Congress could easily be starting from a very different place when it takes up mortgage finance reform. In contrast to the system today, there may be a single GSE security; a consolidated platform for issuing them that can be used by other issuers as well; a much more robust participation by private risk-bearing capital within the current framework; tighter and better clarified “rules of the road” for managing counterparty risk in both directions; and a clearly defined set of expectations for the GSEs’ duty to assure broad access beyond the specific housing goals.
As Director Watt moves beyond the “listening” phase of his tenure and more fully into the “execution” phase, the decisions that he makes in directing how Fannie and Freddie fulfill their broad obligations to fully serve US mortgage markets will reverberate loudly in future congressional discussions.
Like it or not, the current system is about to undergo a significant series of make-overs, whose implications we will be living with for quite some time.