While it is clear that the recovery of the housing markets is well underway, it is all too easy to overlook that today's housing finance system has been largely nationalized.  Three members of BlackRock asset management's Government Relations division write in a Viewpoint article that despite the discussions among many policymakers articulating the desire to reduce government support and attract more private capital, "there continues to be policy and regulatory initiatives that discourage the return of private capital to the sector."

"HOUSING FINANCE UPDATE:  The Conundrum Continues..." by Barbara Novick Vice Chairman and Head; Kevin Chavers, Managing Director; and Alexis Rosenblum, Associate, describes the foundations of the recent recovery as fragile and say a number of impediments remain:

Housing Activity:  The rebound has been spurred by investors rather than homeowners and these cash buyers have substantially reduced inventories.  If inventories rebuild it could put pressure on prices.

Structural impediments:  These include weak income growth, high unemployment, and the burgeoning student loan debt which has encouraged some to abandon or postpone homeownership

Credit Constraints:  Due to tightened underwriting and the regulatory concerns of lenders.

The recovery has featured an extraordinary level of government support; with government behind almost 100 percent of newly originated mortgage loans, and the government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac along with Ginnie Mae account for almost all new mortgage-backed security (MBS) issues and the Federal Reserve's monetary policy and mortgage buying program have been vital to the recovery. 

Even though the consensus is the system must attract more private capital, in the "absence of legislative reform, multiple regulatory agencies continue to forge ahead with piecemeal efforts that are effectively altering the current housing finance landscape."  Many policy initiatives to date have been fragmented and in some cases "effectively discourage private capital from the sector," the authors say.  The patchwork of efforts "creates uncertainty and suggests a lack of political will and path to achieving a solution-oriented policy objective. There is concern about investors' perception of policy risk caused by this lack of a clear and consistent approach to housing policy."

The article recaps many of the policy and legislative initiatives either underway or under consideration.

A recent report of the Housing Commission of the Bipartisan Policy Center (BPC)  proposed winding down and eventually eliminating the GSEs over a number of years, replacing them with a government-owned corporation that would provide a "limited catastrophic government guarantee". Option Three of the Obama Administrations 2011 White paper is largely in agreement with the BPC proposal.

The Federal Housing Finance Agency (FHFA), conservator of the GSEs, is spearheading a host of initiatives under the umbrella of its "Strategic Plan." 

  • A call for building a new secondary market infrastructure which the GSEs would jointly develop and own.
  • A Uniform Mortgage Data Program to enhance disclosures and allow the market to better understand and ultimately price and absorb additional credit risk.
  • A directive to GSEs to steadily increase guarantee fees and actively evaluate other forms of credit risk dispersion;
  • A call for an accelerated disposition of "illiquid" assets held in the GSEs' retained portfolios,

In April FHFA directed the GSEs to extend the Home Affordable Refinance Program (HARP) by two years.  BlackRock says HARP is an effective program but continued changes to its parameters have heightened investors' concerns about uncertainty and policy risk and may discourage private capital. 

In addition to the GSE reform initiatives being implemented by FHFA, regulatory agencies are promulgating key rulemakings required by the Dodd-Frank Act including the "Ability to Repay" rule, the definition of Qualified Mortgage, Qualified Residential Mortgage, National Servicing Standards and the Risk Retention Rule.

Finally, the reform of the credit rating agencies pursuant to Dodd-Frank will also have a material impact on the re-emergence and functioning of the private label MBS market. Regulators need to develop a clear understanding of how investors use credit ratings and to establish agreement on the objectives of credit rating agency reform, particularly measures that increase transparency of data while discouraging measures that attack the fundamental business of credit rating agencies.

The legislative focus of current housing finance policy is also the reform and/or elimination of the GSEs.  A number of GSE-related bills have been introduced in Congress over the past five years, however the authors say until recently most appeared to be political statements or "messaging" bills rather than practical and solutions-oriented.  Recently more comprehensive legislation has been introduced and President Obama has spoken publicly about the need to reform the agencies.

All of this is complicated by the recent financial successes of the GSEs.  Their contributions to Treasury have materially contributed to deficit reduction and, coupled with increased tax receipts, have helped delay the need to raise the debt ceiling.  Another complication is the series of recent legal challenges by GSE shareholders and affordable housing groups regarding amendments to the Senior Preferred Purchase Agreement by the US Treasury.

Given the importance of the GSEs, any reform must include a clear plan for an orderly transition to a new system that does not impair liquidity, pose a threat to existing investors or interfere with the orderly functioning of this multi-trillion dollar market or impair the its current recovery or long term stability.

There is also pending reform legislation.  The "Housing Finance Reform and Taxpayer Protection Act", (the Corker-Warner bill) would replace Fannie Mae and Freddie Mac with an entity called the Federal Mortgage Insurance Corporation ("FMIC"), a single government guarantor.  It would charge guarantee fees to provide a full-faith-and-credit backstop on mortgaged-backed securities (MBS) provided that a private guarantor took a 10% first-loss risk position.  

The bill also proposes that the FMIC establish a mortgage insurance fund, maintain a database of uniform loan level information on eligible mortgages, develop standard uniform securitization agreements, and oversee the common securitization platform currently being developed by the FHFA. Fannie Mae and Freddie Mac would be wound down over a period of time, their assets available to the new entity.

This bill has garnered attention as the first bipartisan piece of legislation addressing comprehensive reforms. However, Senate Majority Leader Harry Reid recently questioned the President's recommendation to eliminate Fannie Mae and Freddie Mac, so the bill's pathway to final passage remains uncertain.

Jeb Hensarling, Chair of the House Committee on Financial Services has introduced a bill entitled "Protecting American Taxpayer and Homeowners Act" (the "PATH Act" ) which seeks to attract more private capital to the sector but calls for no future government support beyond a reduced role for the Federal Housing Administration (FHA). It would eliminate Fannie Mae and Freddie Mac over a five year period and accelerate the reduction of their retained portfolios.

PATH would also re-define the mission of FHA by limiting its support to first time and low-to-moderate income homeowners and reduce FHA mortgage insurance coverage from 100 percent to 50 percent.  The bill calls for the maintenance of a privately owned securitization platform, seeks several changes to the Dodd-Frank housing requirements and to spur development of the covered bonds market. Finally, the bill would prohibit a GSE or FHA from backing any loan in a jurisdiction that utilized eminent domain to seize mortgages.  

President Obama recently laid out four core principles for housing finance reform: 1) private capital should be at the center of the housing finance system with a more limited role for government; 2) ensure no more taxpayer bailouts by winding down the GSEs; 3) maintain widespread access to 30-year fixed rate mortgages; and 4) support affordability and homeownership for first-time buyers as well as access to home rentals for those who cannot afford to buy a home. This is again similar to "Option 3" from the Administration's 2011 paper.

The authors say they are encouraged by the Corker-Warner bill's preservation of a full-faith-and-credit guarantee of securities and the bi-partisan support for the bill but it raises both substantive and political questions; is there sufficient private capital available to assume the 10 percent first loss credit risk position?  Is that cushion excessive, given that Moody's Analytics views 5 percent as more than adequate to weather future financial storms?"   Assuming the 10 percent first loss capital cushion is available, is this likely to unduly impair borrowers' access to mortgage credit and reduce liquidity, impeding recovery and putting a substantive burden on future homeowners?  The bill also faces a number of political hurdles.

The PATH Act raises a host of questions as well. The elimination of any form of government guarantee would likely materially impair the availability and increase the cost of mortgage credit. The Hensarling Bill passed out of the House Financial Services Committee on a straight party line vote in July however most observers place a low probability on it final passage.

The authors say they continue to believe that the retention of a government guarantee is essential to any reform and that it is vital that any major legislation provide clarity and certainty regarding the scope of the guarantee to be provided.  Moreover, an orderly transition must provide for fungibility of the existing GSE securities and any new securities that would result from reform. These principles are vital to maintaining liquidity, without disrupting the efficient functioning of the mortgage markets. Every housing finance reform proposal must be evaluated against these principles and the resultant impact on the stability of the housing market.

The Federal Housing Administration is also targeted by reform other than that of PATH.  The FHA Solvency Act of 2013 recently voted out of the Senate Banking Committee would raise the minimum capital reserve ratio of the Mortgage Mutual Insurance Fund to 3 percent and give the Department of Housing and Urban Development (HUD) special tools to address FHA's failure to meet the goal. It would also increase minimum annual mortgage insurance premiums and reevaluate them annually to ensure they cover expected risk and maintain the capital reserve ratio. This bill does not seek to reduce the insurance coverage of FHA nor redefine its mission like the PATH bill and the authors say they are somewhat more optimistic about its future.

The authors single out two factors that they believe are singularly harmful to recovery and reform, especially the reentry of private capital. The first is the use of eminent domain as proposed in some localities to seized mortgages from MBS and restructure them.  The second is the National Servicer Settlement.  The eminent domain issue, the authors say, would have a profound impact on national housing policy and global markets.  They support suggestions and the PATH legislation that would prohibit the GSEs and/or FHA from doing business within any locale that so utilizes eminent domain.   

The Servicer Settlement, they say, unwittingly allowed sanctions on servicers to be paid by private investors and the same construct has been adopted by the Federal Reserve and the Comptroller of the Currency in their servicing settlement actions.  This will deter investors from putting money at risk and is at cross-purposes with the public policy goal of attracting private capital.

In conclusion the article says that while there are differing views about the proper degree of government support there is an emerging consensus that any serious approach to reform of the housing finance system must attract more private capital and reduce the unprecedented level of government support currently in place. The authors restate the need for a holistic, coordinated approach to reform rather than one that works at cross-purposes with the goal of attracting private capital.