Calling it the final piece of unfinished business from the financial crisis, the Mortgage Bankers Association (MBA) has published a paper with its recommendation for comprehensive reform of Fannie Mae and Freddie Mac (the GSEs).  The Association says that over the years, various proposals introduced in the House and Senate, while producing useful discussion, all stumbled for a variety of reasons including fear of exacerbating the impact of credit or economic cycles or perceived lack of a sufficient affordable housing strategy.

MBA says Congress needs to act because only a legislative solution can provide political legitimacy and long-term market certainty for the housing finance system.  This includes the need to reinforce reforms the GSEs and their conservator and regulator the Federal Housing Finance Agency (FHFA) have already made and to protect those reforms from political winds and changing administrations while addressing the systemic issues that helped create the housing crisis.  Only Congress can create an insurance fund to support an explicit government guarantee for eligible securities, a necessary ingredient for reassuring investors in the housing market.

Federal support for the GSEs, including the backstop provided by the U.S. Treasury through its Preferred Stock Purchase Agreement (PSPA) will be essential for any transition period.  However, the paper says, "calls for a piecemeal 'recap and release' approach or the suspension or modification of the dividend owed to Treasury ignore the need for a permanent solution as well as the importance of structural reforms that would address the deficiencies the contributed to the failure of the GSEs."  Allowing the GSEs to retain the dividends that are now "swept" into Treasury each quarter would be insufficient to provide an adequate cushion against potential losses.

The Association says its Task Force for a Future Secondary Mortgage Market considered many potential models but while evaluating the tradeoffs among them, several key features stood out as critical to ensuring the secondary market's long term health.

• Leveraging the benefits of competition and strong regulation;
• Ensuring equal market access for all lenders
• Preserving a strong public mission; and
• Maintaining a deep, liquid market for long term single- and multifamily financing options.

With these principles in mind the Task Force supports a reformed end state comprised of multiple guarantors, hopefully more than two, organized as privately owned utilities with a regulated rate of return.  Their public purpose would be to provide sustainable credit to the conventional mortgage market and to lenders of all sizes and business models.  They would also be responsible for executing an affordable housing strategy ensuring broad credit access, developing affordable options, and addressing underserved markets nationwide. Guarantors would be charted to acquire single and multifamily mortgages and issue securities wrapped with an explicit guarantee from the federal government ensuring timely payment of principal and interest in the event a guarantor failed. 

This end state would arise in part from many existing reforms including the Common Securitization Platform (CSP) and the Single (GSE) Security.  The MBA proposal would also expand on the GSEs credit risk transfer programs and the expanded Seller-/Servicer base.

The federal guarantee would be funded by insurance premiums paid by the chartered guarantors to a dedicated Mortgage Insurance Fund.  Each guarantor would be required to leverage private-capital investors to share credit risk above and beyond the loan level credit enhancement provided by the primary market.

The end state would need to be built around a group of core principles:

• Preservation of the 30-year fixed-rate, pre-payable single-family mortgage (SFR) and long term financing of multi-family mortgages
• Maintenance of a deep, liquid TBA market for conventional SFR.
• Eligible single and multi-family MBS carrying a government guarantee funded by insurance premiums. The guarantee would attach to the MBS only, not to the guarantors or the debt.
• The availability of affordable housing, addressed along a continuum and incorporating both single- and multi-family approaches for both owners and renters.
• Facilitation of equitable, transparent, and direct access to the secondary market for all lenders.
• Space for a robust, innovative, and purely private market.
• Preservation of existing multifamily financing with new options permitted.
• Reliance on strong, transparent regulation with private capital assuming most of the risk, but with a provision for a deeper level of government support in the event of systemic crisis.
• A "bright line" between primary and secondary mortgage markets, applying to both allowable activities and scope of regulation.
• Risks during transition should be minimized along with any operational disruptions.

MBA says it recognizes that a privately owned, multi-guarantor secondary market supported with a government guarantee "wrap" of eligible MBS carries certain risks so its proposal also has a long list of "guardrails" designed to protect taxpayers, preserve what is already working, and align incentives across both primary and secondary markets.  Many of the guardrails it presents in the reform paper are restatements of the above principles but a few additional safeguards are included in the list.

• The reformed end state should allow for unlimited regulatory charters for guarantors meeting statutory requirements to be approved to issue guaranteed MBS.
• Guarantors must be standalone companies and prevent undue influence by a controlling shareholder. Lenders may not own shares of a guarantor.
• Guarantors should be regulated as Systemically Important Financial Institutions (SIFIs) and their return on capital regulated, with guarantors supporting an affordable housing strategy.
• Guarantors may not hold investment portfolios. They may hold a liquidity and contingency portfolio for delinquency and loss-mitigation purposes and a limited multifamily portfolio as well as a short-term portfolio of cash window operations.
• New guarantors will be able to apply as single-family, multi-family, or as an operator in both markets.
• Congress should make the CSP an independent, government owned corporation available to new guarantors.
• The CSP would own all GSE historical single-family data which would be available to market participants for an administrative fee.
• The CSP should operationalize and manage to the government's "QM-like" single-family eligibility parameters to receive the guarantee.

The transition to a new end state would be the most critical component of reform and must be designed to minimize disruption.  "This means that the existing operations of the GSEs could be reformed and repurposed to serve as initial guarantors.  MBA suggests several principles that should govern the transition.

• Preservation of the PSPAs until the new end state is fully functioning and capitalized.
• Staging the transition over several years to avoid disruption and allow the market to build capital
• Allowing new entrants to develop as soon as possible to encourage competition.
• Keeping existing human and operational capital at both GSEs in place where possible.
• Congress should, where possible, use existing legal authorities and consider separating the existing books of business from newly guaranteed books
• The regulator should be given, within a Congressionally mandated framework, sufficient flexibility to adjust the transition based on market condition or other factors.

MBA says it will release a paper elaborating on the one released this week that will include more details on its end state recommendations as well as a transition plan.