The
second proposal for reform of the housing finance system in a week was just
introduced by the National Association of Realtors® (NAR). Their "vision" for
reform is centered on Fannie Mae and Freddie Mac (the GSEs). The future of the
two companies, in federal conservatorship since 2008, barely got a mention in
the outline for reform legislation released a few days ago by Mike Crapo
(R-ID), chair of the Senate Bankin Committee.
NAR
unveiled its proposal, developed in collaboration with Susan Wachter, the
Albert Sussman Professor of Real Estate and Professor of Finance at The Wharton
School of the University of Pennsylvania, and Richard Cooperstein, head of Risk
Management at Andrew Davidson and Company, Inc., before a sold-out forum audience
of 400 on Thursday.
The
proposal says the GSEs do much more than buy mortgages, package them into
securities, and sell them to investors with a guarantee. They also set, monitor, and enforce standards
for mortgage origination, credit, servicing, and prepayment in the $5 trillion
conventional mortgage market. They provide the infrastructure and scale
required in the investment markets for interest rate and credit risk and
facilitate more competition than would exist without them.
NAR's
take on why the GSEs foundered was insufficient capital, guarantee fees that
were too low, inadequate regulatory oversight, and ruinous competition from
unregulated providers (subprime lenders.) The GSE could chase the market
because their returns and mission were not regulated. "They could not capture the benefits of
setting good credit standards."
The
nation needs a liquid mortgage market that is efficient and stress resilient to
meet the home financing needs of middle America and provide access for
underserved communities. Today the
taxpayer is exposed to loses because of the lack of private capital, but the
need for continuing federal support is also apparent.
NAR
proposes the GSEs be structured again as government-chartered utilities, but this
time with improved accountability and regulatory oversight. This structure
would strengthen adherence to mission and regulates returns to leverage the discipline
of private capital while limiting the profit motive.
Today's
GSEs have a stronger regulator in the Federal Housing Finance Agency (FHFA) and
public oversight from Congress. They are restricted in the products they can
buy, the size of the portfolio, and their ability to lobby. They also transfer most of the interest rate
and credit risk on the mortgages they guarantee to the private sector. In essence, "the GSEs' operations are
reformed, but their ownership structure and oversight remain to be determined."
NAR
suggests re-chartering the GSEs as Systemically Important Mortgage Market
Utilities (SIMMUs), similar to the Systemically Important Financial Market
Utilities (SIFMUs) established under Dodd-Frank. Like the SIFMUs, failure of an
unregulated GSE could create or increase the risk of significant liquidity or
credit problems spreading among financial institutions or markets and
threatening the stability of the U.S. financial system. SIFMUs
are overseen by the Financial Stability Oversight Council (FSOC), an enhanced
FHFA would oversee the SIMMUs.
This
structure would support the public missions of liquidity and broad access
through its board and its enhanced oversight while shareholder equity provides discipline.
The public mission of the SIMMU should supersede competitive motivations and
benefits of shareholders in a manner consistent with the legal construct of a Beneficial
Corporation. The entities would report
to Congress on the strength of the business and performance against their
public mission on a regular basis, but they would not be able to lobby and
would fund their operations outside the government appropriations process
through fees as the GSEs. Their returns
would be regulated.
The
utilities would continue to set standards for residential mortgages and to
transfer most of their risks to private capital markets; interest and
prepayment risk through the To-Be-Announced (TBA) market and credit risk through
existing credit risk transfer (CRT) and related credit risk programs. MBS would
carry an explicit, paid-for, catastrophic guarantee provided by the U.S.
government to enhance liquidity and support the TBA and CRT markets and
long-term financing in turn.
The
entities would retain enough risk to align incentives and enough capital to
protect taxpayers from losses in all but the most extreme circumstances. This
capital requirement reflects their role as insurance utilities and includes
product, counter-party, and balance sheet risks, along with their
countercyclical obligations.
NAR
suggests a 5 percent claims-paying ability, from guarantee fees, capital, and
risk transfer, would be enough to survive a 2007 type crisis. Under extreme stress, the U.S. Treasury
backstop would provide additional liquidity.
The
entities would only guarantee mortgages that comply with the Qualified Mortgage
standard of the Ability-to-Repay Rule (ATR). They would require 20 percent
borrower equity or credit enhancement from private insurance. The entities would continue to enforce capital
and operational standards for servicers and credit counterparties that protect
taxpayers while achieving the public mission. They would also provide and maintain the
infrastructure for securitization and credit risk sharing with private markets.
Additionally,
the proposal says there must be access for small lenders, clear and fair
pricing and support for 30-year fixed-rate mortgages. The entities must make significant
investments in data and research and programs to expand access to mortgages
including first-time homebuyers and targeted populations. The Duty to Serve
mandates, and contributions to the Capital Magnet Fund and Housing Trust Funds
would continue.
Government
programs may support a similar mission, but without reliance on private capital.
Proposals that would eliminate or shrink the GSEs would reduce liquidity in the
market and cause government programs to expand, increasing risk to tax
payers. Both efficiency and equity goals
are accomplished through the SIMMUs-financial market utilities that receive
regulated returns and execute the government's mission for housing finance.
Transition
to any type of important financial market must not cause disruption. Mortgage
markets are currently functioning smoothly so the final model and the
transition process must be telegraphed to the markets. The advantage of their proposal NAR says, is
that it builds on two existing entities and their infrastructure, retaining
many of the reforms already made. Congressional action would be needed to
re-charter the GSEs into SIMMUs.
The
SIMMUs would continue to maintain and develop the infrastructure of the
conventional mortgage market, and the regulator would oversee the issuance of
required stock analogous to an Initial Public Offering. It is estimated that $100-$200 billion (2 to 3
percent) of equity capital would be needed to back the SIMMUs, supplementing
the existing guarantee fees and risk sharing structures for a 4 to 5 percent
claims paying ability. Experts say this
could be achieved through two or three offerings so the new SIMMUs could be up
and running within two years, well-capitalized, with a stronger regulator and
clearer public mission.
Pricing
of the guarantee fee is critical to accomplish the mission and to attract
private investors but raises a number of important questions. What is the right
guarantee fee that fairly prices risk and protects taxpayers? How much should
the utilities charge to raise and maintain equity and sell risk into the
market? Will the market be disrupted in achieving a market rate?
For
an extended period before the financial crisis, the GSEs had 0.45 percent statutory
capital for credit risk and 2.50 percent for portfolio assets, charged about 20
basis points (bps) guarantee fees, and generated high returns on their
highly-levered balance sheet. During the crisis the GSEs cost the taxpayers
nearly $200 billion, or about 4 percent of $5 trillion notional balance
mortgages, a loss nearly ten times their required capital. Since then, about
$2.5 trillion of notional balance CRT has been issued, transferring risk and
providing extensive discovery on the price of risk and implied capital required
for GSE credit risk. From 2011 to 2014, guarantee fees were raised in a series
of steps to roughly 55 bps.
NAR
says its proposal uses conservative estimates and comes to about the same fee
level. Part of that fee would be used to
purchase risk-based catastrophic protection similar to deposit insurance from
the U.S. Treasury.