Fannie, Freddie reforms draw encouragement, warnings

James Millstein: Don’t just trash the assets supporting the housing market

Five years ago, lawmakers largely agreed that a two-year wind down of Fannie Mae and Freddie Mac would be appropriate given the wave of troubles sweeping through the GSEs and the nation’s housing market at the time.

At least that’s what Sen. Mark Warner, D-Va., remembered when speaking to housing reform advocates during a Senate Banking Committee hearing Thursday on how to smoothly transition the GSE-dominated market to a housing finance system that protects taxpayers, while offering robust mortgage credit. 

But a few years can make a big difference in viewpoints. Today, everyone wants the GSEs gone. They just don’t know how to do it, without tearing up the one string that is holding the entire U.S. housing market together.

The takeaway from the most recent Senate Banking hearing on the subject is no one likes the GSEs, but everyone admits they’re in control for now and cannot be pitchforked to death with private capital and a structure already in place.

Sen. Warner reminded panelists that the 2008 wind down initiative – which is now deemed impractical – received a great deal of support from both sides of the aisle.

Yet, Sen. Warner asked panelists, "When are you ever going to hit that magical time? That may be an unobtainable goal,” he told the panel. "My point is you have to start this process, waiting for the perfect moment leaves a huge amount of uncertainty over this market that is terribly important to our economy."

But finding the right plan – one that brings private capital back in without disrupting mortgage credit is difficult and often creates points of differentiation among housing reform experts, the testifying panelists noted.  

One of those panelists – James Millstein, CEO of Millstein & Co. and a key player in the 2008 restructuring of AIG – warned panelists about a dramatic wind down of the GSEs. Millstein said a transition without the supporting entities still functioning in some capacity could curtail mortgage credit, creating a risky proposition for the nation’s housing market and economy. 

He noted that without the right supports, "You are depending on tens of thousands of different investment managers, saying they will build this with you."

He added, if they don’t come, then you’ve essentially shut down your entire mortgage market.

Instead, he recommends a restructuring plan that maintains the core of the agency’s function until private capital can effectively fill in those holes.

Millstein told lawmakers he supports the intent of Senate Bill 1217 – the Housing Reform and Taxpayer Protection Act – but has a few caveats of his own.

One of those being the need to keep Fannie and Freddie operating in some capacity during the transition. The legislation proposes the creation of the Federal Mortgage Insurance Corp. (FMIC), which would replace Fannie Mae and Freddie Mac, providing a government backstop for investors in mortgages. However, the backstop would only be triggered after private investors have taken a substantial portion of the first-risk.

Millstein’s not against the plan or private capital, but says in prepared testimony, “the one viable path" includes restructuring, recapitalizing and privatizing the single-family and multifamily guarantee businesses of the GSEs. 

He says doing so would ensure a durable layer of private capital before the FMIC backstop takes effect.

Millstein’s plan calls for eliminating the GSEs charters, winding down the portfolios, while allowing them to still facilitate the purchase of mortgage loans from small banks and credit unions and to manage the workout of the troubled loans they guarantee.

He then says to fully privatize the single and multifamily businesses, separately subjecting them to safety and soundness requirements.

"In short, I propose fixing the problems with these businesses and using what remains to bridge to your new system," he explained.

The idea is to ensure mortgage credit doesn’t contract, that the market is not leaning too heavily on unseen private investors and making sure the Treasury is not saddled with losses from remaining Fannie and Freddie liabilities.

Millstein’s chief concern is that a final plan to move away from the GSEs will remove some of the stability that the current GSEs do offer to today’s market – even if they are not the ideal.

"You should not trash the assets that are currently doing this for the market," he said. “That to me is crazy."

While Millstein is weary of a hard and fast deadline for reform, Mark Zandi, chief economist of Moody’s Analytics (MCO), agreed the process should be handled with care, but laments the negative influence a GSE-dominated market can have on housing.

"The longer Fannie and Freddie stay in government hands, the more lawmakers will be tempted to use them for purposes unrelated to housing," Zandi said. "This has already happened. Last year’s payroll tax holiday was partially paid for by raising the premiums Fannie and Freddie charge homebuyers for providing insurance."

And while he recognized the transition away from GSE dominance can be tricky, he sees no other solution than to move forward with it.

He warned that policymakers may eventually face the temptation of using the GSEs to lend again to people who cannot afford mortgages, taking the country back to where it was before the housing crash. He believes the current proposals still need work, saying they "lack a clear plan for getting from the current housing finance system to the future one."

Still, he concluded his testimony, saying "it is eminently doable." He views the GSEs as unfinished business and suggested it’s time to pursue serious reforms.

Despite his eagerness to see reform, Zandi believes it's critical the GSEs continue operating until a new system is operationally functional.

Yet, John Taylor, president and CEO of the National Community Reinvestment Coalition, responded to the Friday debate in Congress with a warning on how an end to Fannie and Freddie would disrupt the housing finance system as we know it, freezing out low-to-moderate income borrowers and the young homebuyers who essentially provide fuel to the market.

His group has been taking a hard look at a world without Fannie and Freddie — or the affordable housing goals that, he says, have already been lowered by FHFA. Taylor notes that historically, many new buyers, and a large part of the entire market, have been served by the GSEs.

"It's very appalling how little thought has been given to that," Taylor told HousingWire. He notes that back in 08' and 09', the affordable housing goals accounted for $500 billion worth of securitizaton of affordable mortgages, but they have been declining ever since. Ten years from now, he estimates only $5 billion in loans for this segment will be securitized — a drastic reduction in credit availability.

His concern is that without Fannie and Freddie, affordable housing goals may continue to deteriorate outside the GSE structure.

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