Last week, with considerable fanfare, the Mortgage Bankers Association released its plan for reforming the housing finance system, including a resolution of the nine-year old federal conservatorship of the government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. This week ICBA, which represents independent community banks, more quietly released its blueprint for reform.
The paper, titled ICBA Principles of GSE Reform and a Way Forward notes that the placement of the GSEs in conservatorship in 2008 was described back then as a "temporary time-out" to allow both companies to stabilize. After eight years, and into a third presidential administration, Fannie and Freddie, although they have returned to profitability, worked through most their defaulted loans, and continued to provide liquidity to the housing market, have less capital today than when they were placed under government control.
ICBA states its members' position. The GSEs have provided a steady, reliable source of funding for home mortgages through all economic cycles and have developed a strong, liquid global market for mortgage backed securities (MBS) that trade with the same ease as U.S. Treasury debt and securities. "The GSEs operate as friendly aggregators and a source of capital for mortgage lending institutions of all sizes and charters."
Community banks, the paper states, rely on the GSEs for direct access to the secondary market without selling their loans to a larger institution in competition with them, allowing them to retain servicing on their loans which helps keep delinquencies and foreclosures low. Their mandate to serve all markets at all times means community banks don't have to face severe curtailment of their businesses when private investors and aggregators choose not to serve smaller or distressed markets.
The paper sets forth ICBA's principals for reform.
- GSEs must be allowed to rebuild their capital buffers. No matter the approach to reform, the system must be well capitalized to prevent market disruption or additional taxpayer support during what is likely to be a lengthy debate and transition period to any new finance system
- The secondary market must continue to be impartial and provide competitive, equitable, direct access for all lenders on a single loan basis. Pricing to all lenders must be equal regardless of size or lending volume.
- The GSEs must be adequately capitalized, liquid, and reliable enough to serve the entire mortgage industry including under challenging economic circumstances.
- Credit risk transfers (CRTs) must meet targeted economic returns. While the CRTs mandated by the Federal Housing Finance Agency (FHFA) for the GSEs may help mitigate the amount of credit risk to both the GSEs and taxpayers, they also drain revenue from the GSEs and expose them to operational risks. They are illiquid and likely to dry up under market stress. CRTs must reflect a real credit risk transfer, minimize counterparty risk, be scalable, meet a targeted economic rate of return, and not encourage further concentration of mortgage activity in the largest banks.
- There must be an explicit government guarantee as the MBS level, paid for through the GSE guaranty fees at market rates.
- The TBA market for GSE MBS must be preserved.
- There should be a single strong regulator over the GSEs to insure adequate capitalization and promote sound operation.
- Originators must have the option to retain servicing and servicing fees must be reasonable. While servicing is a low-margin business, it is a crucial aspect of the relationship-lending business model. In addition, consumers generally receive better service where their loans are kept local.
- Complexity should not force consolidation. Under the current model, sellers take out commitments to sell loans and are not required to obtain complex credit enhancements except for high loan-to-value ratios or other guarantees. This simplicity must be maintained for community banks and small lenders
- GSE assets such as their automated underwriting technology, the Common Securitization Platform (CSP), and multi-family housing businesses should not be sold or transferred to private market aggregators.
- The purpose and activities of the GSEs should be appropriately limited to a focus on supporting residential and multifamily housing. GSEs must not be allowed to do retail lending.
- GSE shareholder rights must be upheld.
ICBA has a two-tier plan for going forward; reforms that can be done through administrative action by FHFA and those that will need congressional approval. The paper says the goal is to use what is in place and working, address or change what is not. Needed administrative reforms include:
- Ending the net worth sweeps and requiring both GSEs to develop capital restoration plans. These plans would encompass continued use of CRTs, provided they meet a targeted threshold for economic return balancing revenue and capital-building needs with prudent credit risk management standards
- Those plans would be reviewed and approved y FHFA which would establish prudent risk-based and levels and set reasonable timeframes and milestone for achieving re-capitalization. FHFA would monitor performance against plans and release each GSE from conservatorship as it becomes well-capitalized.
- The GSEs should complete construction of the CSP and use it to issue their respective MBS. Launch of the Uniform MBS should be deferred until both GSEs are recapitalized and out of conservatorship.
- Ownership of the CSP should remain with the GSEs through its current LLC structure. Expanding access to other entities should be left to the LLC board with final approval by FHFA.
The needed legislative reforms to be undertaken by Congress include:
- Creation of a catastrophic mortgage insurance fund modeled on the FDIC Insurance Fund, funded through GSE guaranty fees, and administered by FHFA. The fund would stand behind the explicit government guarantee of GSE MBS.
- Rewriting of the GSE corporate charters from the current government-chartered, shareholder-owned publicly traded companies to regulated shareholder-owned financial utilities. All current shareholders should be able to exchange common and junior preferred GSE shares for a like amount of shares of the new structures and Treasury to exercise its preferred GSE stock warrants and convert them as well. No dividends should be paid to any shareholders until the company is deemed well capitalized and the Treasury should be required to divest itself once a company is well capitalized.
ICBA concludes that, while GSE reform will be difficult, it remains critical to the future of the housing market and the U.S. economy. It is confident that a strong plan to improve the GSEs' capital position, grow earnings, manage expenses and restore high-quality service and increased liquidity to the mortgage market "will make the housing finance system safer and more sound, providing access to lenders of all sizes and the communities they serve."