In September of this year, the Trump administration released two housing finance reform plans, one from the U.S. Department of the Treasury addressing the government-sponsored enterprise conservatorship and another focused on the Federal Housing Administration and Ginnie Mae programs under the authority of the U.S. Department of Housing and Urban Development.

The immediate response produced applause from many stakeholders from industry as well as shareholder interests who began to see their light at the end of this decades-long tunnel of conservatorship. The plan also resulted in significant pushback from consumer advocates and civil rights groups concerned that the outcome of administrative action could worsen access to credit for minorities and other first-time homebuyers.

The Treasury plan called for both legislative and administration action but made clear that in the absence of legislation, the administration was ready to move on its own. Calling for steps to crowd in private capital, the plan calls for increased capital and a focus on shrinking the footprint of the GSEs’ relative to roles that could be filled by the private sector. 

“This plan endeavors to promote private sector competition in the housing finance system,” the Treasury paper states. “A driver of the GSEs’ growth has been a regulatory framework that is biased in favor of GSE-supported mortgage lending – a bias that has increased following the enactment of the Dodd-Frank Wall Street Reform.”

Likewise the HUD plan calls for a similar outcome to crowd in private capital, stating, “Through a formalized collaborative approach, FHA and the Federal Housing Finance Agency must work together to ensure that government-supported mortgage programs are not competing and do not crowd private capital out of the marketplace, both in their single family and multifamily programs.”

This is a complicated set of objectives and there are many critical elements set forth in both papers that could have long-term impacts to the housing finance system. But a core element here is to consider what it means to pull back in order to make room for the private sector.

Prior to the Great Recession, the private sector was robust. The PLS markets was vibrant with loans that offered everything from low down payment mortgages to strong credit borrowers, but also extending into subprime, no doc, negative amortization, interest only and more. To a fault, the PLS market had disintermediated both the GSEs’ and FHA’s market power ultimately to a point where FHA, for example, had approximately 3% market share at its low point.

The unsustainable features of so many of these products created this house of cards scenario where almost anyone could get a loan and in the end, when it collapsed, it took the entire PLS market with it. In more than a decade since the collapse, there has been but a trickle of private market growth returning to housing relative to total volume. 

The majority of it has come from whole loan buyers like REITs and bank’s balance sheets who have become competitive in jumbo lending and some non-QM mortgage offerings. But to be clear, there has been no substitute to fill the hole for low down payment first-time homebuyers anywhere but at FHA and the GSEs.

The market for the first-time homebuyer is dependent both on these government supported programs but also the role of smaller lenders, and mid-sized independent mortgage bankers who were particularly important to support the housing market as many of the larger bank lenders pulled away from lending to this segment of the market following the recession.

In fact, it is the smaller to mid-sized lender consisting of community banks, credit unions and independent mortgage bankers that became the majority player in mortgage banking. 

They met the needs of communities across the country that might have otherwise not been served by the lending industry. This segment of the market, with literally thousands of small lenders, helped insure a continuity of credit access when the nation needed it most.

Unfortunately, policy makers now may be headed towards decisions that will reduce these small lenders’ ability to compete. While working to reform the GSEs and HUD and crowd in private capital by surgically weakening the GSEs through reducing their respective footprints using pricing and product terms to constrain their role, we face a potential void in low down payment lending that is critical to the first-time buyer. 

As is stated in the Treasury paper, “FHFA should conduct an assessment of the credit and other risks posed by the GSEs’ underwriting parameters, including acquisitions of single-family mortgage loans with greater risk characteristics such as high LTV, high DTI or risk layering, and that assessment should guide underwriting restrictions to be prescribed by FHFA.” 

Clearly the focus on high LTV is a particular concern.

So, who wins and who loses if the scale back happens? Clearly balance sheet investors will be net beneficiaries. And, while applauding the effort to shift lending back to the private sector and away from the GSE’s and the GNMA programs, one must ask whether this a “cart before the horse” scenario.

First-time homebuyers of the future will be dominated by minorities who, for the most part, lack inherited wealth. Scaling back down payments, implementing risk-based pricing as proposed in the HUD paper, and other steps are worthy of discussion, but we are missing any focus on bringing back a healthy private market to replace that lending. Some argue that GSE reform should be second after focusing on PLS. By going the other way, we may reduce credit access for the diversity of homebuyers of the future.

And, there is another victim here. The small to mid-sized lender, especially IMBs who helped the housing economy move forward when others pulled away, do not have balance sheets to hold loans. They depend on investors. 

Should the government-backed programs pull back, there will certainly be private players to step in for lower LTV, higher credit score product, but the entry-level buyers, and these smaller lenders will be potentially left out.

We should all applaud the efforts of the administration to end the conservatorship. But pulling a leg or two off the stool of housing support should be in concert with the building of a new foundation of support in the private sector, one today that does not exist for most of the first-time homebuyer population in this country. Moving fast should not be the goal for anyone other than perhaps the shareholders and hedge funds who bought these stocks. Disruption of a market that is one the bright spots of the economy should be the first consideration.