The Senate Banking Committee heard from six witnesses on Tuesday on the topic of "Housing Finance Reform: Essentials of a Functioning Housing Finance System for Consumers."  Testimony from witnesses tended to focus on specific areas of interest such as the role of private mortgage insurance.  Additional regulation of servicers, especially as it relates to foreclosure prevention, was a particular area of focus as S. 1217's (the Housing Reform and Taxpayer Protection Act of 2013).  This is among finance reform bills pending in the Senate and the one given the best chance of being enacted in some form.   

Eric Stein, Senior Vice President, Center for Responsible Lending provided the Senators with two sets of policy suggestions.  The first was for ways to structure a reformed housing finance system and how those structures might affect consumers.  The second was a recommendation that underwriting criteria not be hardwired into reform legislation.  Instead, Stein said, a reformed system should allow the regulator, bond guarantors, and lenders to use traditional underwriting practices, including compensating factors, for lower-wealth borrowers.

The new structure, Stein said, should have the following features:

  • Secondary Market entities should have a mutual ownership structure rather than stock ownership. Each mutually owned entity should each be able to issue securities and guarantee them.

    Eliminating private shareholders would curb incentives for short term and volatile equity returns over long-term sustainability.  Lenders wishing to sell conforming loans into the secondary market would be required to invest in one or more of the mutually owned entities and their pooled capital would stand in first-loss position.

    This type of ownership would reduce the chasing-the-market problem exhibited by the GSEs prior to conservatorship and would benefit consumers not only with stability but by limiting the secondary market entities from driving up prices to lenders and borrowers.
  • Smaller lenders should continue to have direct access to the secondary markets through a cash window. The current system provides smaller lenders with direct access to the GSEs but reform proposals such as S 1217 that split the system into separate issuer and guarantor companies threaten this access.

    Should Congress decide to bifurcate the system, Stein said, then it should prohibit lenders from being affiliated with or purchasing stock in either, except through mutual ownership, in order to protect small lenders.
  • Secondary market entities should be required to serve a national market.
  • Reform should preserve the pass-through securities currently used in the TBA market but structured securities should not be able to obtain a government guarantee.
  • Reform should preserve the ability of the GSEs to modify distressed loans. This means a having portfolio capacity to hold modified loans and a government liquidity backstop to support the portfolio in times of economic stress.

Rohit Gupta, President of Genworth Financial's U.S. Mortgage Insurance told the senators that the amount of down payment does matter when it comes to loan performance.  Loans with higher combined loan to value ratios (CLTV) experience higher default rates than those with lower CLTV.  But, he said, there is a responsible way to offer high CLTV loans by making sure they are properly underwritten and have the benefit of credit enhancement in the event of default. 

Mortgage insurers are in first loss position in the event of default so their business model relies on insuring mortgages that are well underwritten.  Detailed underwriting standards have historically been established through regulation, investor guidelines, and market practice rather than by statute but regulators have a much clearer legislative mandate today that will help them guard against the behavior that led to the crisis.  Thus certain broad underwriting criteria defining the "outer edges" of loans with a government backstop could be written into statute.   He cautioned however, that an overly prescriptive approach could limit credit for responsible borrowers and that locking underwriting requirements into statute could make it difficult to make small adjustments over time.

Many proposals for housing finance reform contemplate requiring a "QM" or "QRM" standard for loans subject to government support.  Gupta said his company generally agrees with this approach, with the caveat that it will be important to have credit enhancement such as private mortgage insurance assuming first loss on lower down payment loans to make the need for any government support truly remote.  This credit enhancement should be mandated as "standard" MI coverage rather than "charter coverage" as S1217 does, lowering an investor's loss exposure for a 90 percent LTV loan to 67 percent.

Larry Platt an attorney with K&L Gates, LLP said S1217 addresses mortgage servicing in two ways, first creating the Federal Mortgage Insurance Company (FMIC) which would establish servicing standards for residential mortgage loans and second by creating a securitization agreement with uniform servicing standards.  Neither provision imposes detailed loss mitigation requirements for the benefit of borrowers and Platt said he believes they are not required.  The newly enacted loan servicing requirements of the Consumer Financial Protection Bureau (CFPB) along with the myriad new state and federal regulations that impose increased obligations on servicers to avoid home foreclosures are sufficient.

CFPB went to great pains to focus on the procedures that need to be followed, he said, rather than mandating specific servicer requirements, formulas, and targets for loss mitigation as many consumer groups had requested.   CFPB declined to be so prescriptive, focusing instead on the nature of a mortgage loan, the legitimate needs of investors, the difficulty in developing a "one size fits all" approach and the potential impact on credit availability. Other federal agencies have shared in this public policy reluctance to obligate specific loss mitigation outcomes, and other than requiring specific forms of loss mitigation on specific terms Platt said it is not clear what more S1217 would or could do in this area.

Alys Cohen, Staff Attorney, National Consumer Law Center presented a counterpoint to Platt's testimony, insisting that housing finance reform should include several improvements to existing mortgage servicing rules.   CFPB, she said, has issued a series of procedural requirements for servicers but has declined to mandate affordable loan modifications consistent with investor interests. 

The data show, she said, that almost all delinquent homeowners still get no modifications and those that do seldom get the best terms available.  The system should promote proven methods for modifying loans for optimum performance and should also include a government-backed portfolio capacity to hold the modified loans.

Current requirements also do not fully protect borrowers who are actually in foreclosure from dual tracking.  Those homeowners should be able to obtain a temporary pause in the process while modification is underway.

Turning to force-placed insurance, Cohen said the current system in which the Freddie Mac and Fannie Mae (the GSEs) reimburse servicers for insurance has resulted in vastly inflated prices for borrowers and when borrowers default, for the GSEs and taxpayers.  She urged that the new housing finance corporation be authorized to purchase insurance including hazard, flood, title and private mortgage insurance, directly from insurers which "would decrease costs for borrowers and the corporation by circumventing the kickbacks to servicers that drive up insurance prices."

Lautaro Diaz, Vice President, Housing and Community Development, National Council of La Raza, said that communities of color were not served well in the run-up to the financial crisis.  Latino and immigrant borrowers in particular do not fit traditional credit profiles.  While prime lenders, and FHA and VA offered loans designed to accommodate their unique profiles the majority of private sector lenders shuffled them off to subprime affiliates or simply did not court these borrowers at all.

Today the market is not serving communities of color significantly better. Even as housing prices are rising in many urban markets with heavy minority populations, often faster than income, the credit box continues to tighten.

Housing counseling arose in part as a response to many of these problems. "More than simply increasing financial literacy, counseling is a tool to combat some of the unethical and at times illegal practices employed by a number of subprime lenders targeting of communities of color," Diaz said.  He recommended that reforms to the housing finance system include the following:

  • Inclusion of housing counseling into the programs of the FMIC or other entity that replaces the GSEs.
  • Increased access and affordability in the mortgage market should be an explicit purpose and duty of FMIC. Other steps could include a distinct Market Access Fund to address both homeownership and rental housing for low and moderate income persons and elimination of mandated downpayment requirements.
  • Incorporate measures to help distressed homeowners recover from delinquency or exit homeownership gracefully. To achieve this end, services should be required to work with HUD-approved housing counseling agencies, provide access to all loss mitigation options, and end improper servicing practices such as dual tracking.

National Association of Realtors (NAR) President Gary Thomas expressed concern about what he called emerging barriers to homeownership facing middle class and first-time buyers.  Bankers are leery about issuing new loans because of proposed risk retention rules and ability-to-repay requirements that are set to go into effect next year at the same time that rising interest rates and growing student loan debt is limiting consumers' access to credit, he told the committee.

He urged policymakers to prioritize strong underwriting standards over high down payment requirements and said regulators should follow the standards set by CFPB for qualified mortgages rather than adopting a complex qualified residential mortgage rule.