While the Federal Reserve might not be charged with housing finance reform, it does not mean its immune from the effect of the ultimate reform options are that put in place, Federal Reserve Governor Jerome Powell said in a speech on Thursday at the American Enterprise Institute.
Powell explained that even though the Fed does not design or evaluate proposals for housing finance reform, it is “responsible for regulating and supervising banking institutions to ensure their safety and soundness, and more broadly for the stability of the financial system.”
Powell’s speech Thursday morning comes amid a growing call for reforming the government–sponsored enterprises. Associations including the Independent Community Bankers of America, National Association of Federally-Insured Credit Unions and Mortgage Bankers Association have all already submitted proposals on how they think GSE reform should be tackled.
In fact, the MBA came out in support of Powell's speech, “Governor Powell’s speech is very consistent with our principals. Obviously our paper has a lot of detail to it that goes further than the speech, but it is very consistent and helpful to the effort of getting progress made towards reform. Governor Powell makes a very good case as to why we need to move forward towards reform and not be complacent with this current status or the model of the past that led to conservatorship in the first place,” said Dave Stevens, MBA president and CEO.
But Powell’s stance on GSE reform is different given that he is coming at the problem from the angle of a Fed governor. But in his speech, his overall call was the same: there is an “urgent need for fundamental reform of our system of housing finance–the great unfinished business of post-financial crisis reform.”
Since it’s been more than eight years since Fannie Mae and Freddie Mac were placed into conservatorship, Powell warned that the next few years may present the last best chance to finish these critical reforms, as memories of the crisis fade.
To Powell, the key to housing finance reform is to apply the lessons of banking reform to housing reform.
“The post-crisis reform program for our largest banks presents an appropriate standard against which the housing finance giants should be judged. After eight years of reform, our largest banking institutions are now far stronger and safer,” he said.
For example, he stated that common equity capital held by the eight U.S. global systemically important banks has more than doubled to $825 billion from about $300 billion before the crisis. After the crisis revealed significant underlying liquidity vulnerabilities, these institutions now hold $2.3 trillion in high-quality liquid assets, or 25% of their total assets.
So for the GSEs, Powell said, “The most obvious and direct step forward would be to require ample amounts of private capital to support housing finance activities, as we do in the banking system. We should also strive for a system that can continue to function even in the event of a default of any firm. No single housing finance institution should be too big to fail.” As it stands, Fannie Mae and Freddie Mac must reach a 0% capital buffer by 2018.
Powell laid out some principles for reform based on the lessons he’s learned from the old system's collapse, and from the experience of post-crisis bank reform.
1. Future housing bailouts
"First, we ought to do whatever we can to make the possibility of future housing bailouts as remote as possible. Housing can be a volatile sector, and housing is often found at the heart of financial crises. Our housing finance institutions were not–and are not–structured with that in mind. Extreme fluctuations in credit availability for housing hurt vulnerable households, reduce affordability and availability, and, as we have seen, can threaten financial stability."
2. Government guarantee
"Some argue that government cannot avoid bearing the deep-in-the-tail risk of a catastrophic housing crisis. A number of proposals incorporate a government guarantee to cover this risk, to take effect after a significant stack of private capital is wiped out.
If Congress chooses to go in this direction, any such guarantee should be explicit and transparent, and should apply to securities, not to institutions. Reform should not leave us with any institutions that are so important as to be candidates for too-big-to-fail."
3. Increase competition
"We should promote greater competition in this market. The economics of securitization do not require a duopoly. Yet there is no way for private firms to acquire a GSE charter and enter the industry."
4. Use the existing housing finance system
"It is worth considering simple approaches that restructure and repurpose parts of the existing architecture of our housing finance system. We know that housing reform is difficult; completely redrawing the system may not be necessary and could complicate the search for a solution."
5. Find a bipartisan solution
"We need to identify and build upon areas of bipartisan agreement. In my view, at this late stage we should not be holding out for the perfect answer. We should be looking for the best feasible plan to escape the unacceptable status quo."
“It is ironic that the housing finance system should escape fundamental reform efforts. The housing bubble of the early 2000s was, after all, an essential proximate cause of the crisis,” he said. “While post-crisis regulation has addressed mortgage lending from a consumer protection standpoint, the important risks to taxpayers and the broader economy and financial system have not been robustly addressed.”
Powell concluded, “Housing finance reform will protect taxpayers from another bailout, be good for households and the economy, and go some distance toward mitigating the systemic risk that the GSEs still pose.”