ACTION PLAN FOR GSE REFORM
Community Home Lenders Association
[September 28, 2015]
It is now more than seven years since Fannie Mae and Freddie Mac were taken into conservatorship. Congressional housing finance reform efforts have foundered over many issues, including whether there should be a government guarantee of MBS, the future of Fannie Mae and Freddie Mac, whether and how to structure a Duty to Serve all segments of the market, and the basic architecture of a reformed system.
Continued Congressional failure on housing finance reform, combined with an understandable reluctance on the part of FHFA as conservator to take substantive actions to change our housing finance system in the absence of Congressional approval, have led to stalemate and inaction. The risk of continued inaction is that reform will be in the end be driven by outside, random events, instead of a carefully designed plan.
In this background, the Senate Banking Committee has approved provisions designed to transition to comprehensive Congressional reform at a later date. While CHLA agrees with this concept and some of the pending provisions, many of them have implications for the ultimate shape of housing finance reform.
CHLA is concerned that some of these provisions could tilt reform back in the direction of market domination by big lenders – and particularly the big banks with securities affiliates, the very firms that dominated the subprime securitizations that played a major role in the 2008 housing crisis. This could reverse changes FHFA and the GSEs have made (eg., moving towards G Fee parity) to create a more competitive market, at a time when non-bank mortgage lenders have stepped in to fill gaps created by the banks’ retreat from lending to lower income, lower FICO score borrowers.
CHLA OBJECTIVES OF HOUSING FINANCE (GSE) REFORM
- Preserve a Government Guarantee. Preservation of an affordable and accessible 30 year fixed rate mortgage is dependent on maintaining access to a broad range of national and international investors that invest in fixed income securities on an interest rate (as opposed to a credit) basis. This underscores the need for a continued federal guarantee of mortgage backed securities (MBS), with proper taxpayer protections as outlined below.
- Protect Taxpayers. The pre-2008 GSE model of private gain, public loss should be replaced by one that includes specific reforms to protect taxpayers, including:
– An explicit (not implied) government guarantee of either qualified MBS or loans.
– G Fees commensurate with the risk of that guarantee.
– Risk sharing to reduce government loss and interject market discipline.
– Basic underwriting guidelines for sound loans for low/middle income borrowers.
– Sound financial regulation with full regulatory powers (eg., FHFA).
- Market Discipline. Appropriate off-loading of risk through risk sharing, to impose the discipline of private sector loss, and to reduce political pressure to make risky loans.
- Access to Credit/Consumer Focus. Consumer provisions are needed, including:
– A counter-cyclical provision to waive or reduce risk sharing requirements during significant market dislocations, in order to ensure reliable mortgage access to credit.
– Duty to Serve –a govt. guarantee should not be used to serve only the best borrowers.
– Assessments for Housing Trust Fund, Capital Magnet Fund, and Market Access Fund.
– Requirements for Appropriate Loss Mitigation.
- Prevent Market Concentration. Protections to enhance mortgage competition must:
– Ensure a price-competitive Cash Window to meet the needs of all small/mid-size lenders.
– Maintain ability of small/mid-sized lenders to securitize government guaranteed loans.
– Prohibit anti-competitive practices – ie., volume discounts & securities firms using their role in providing risk sharing to deal exclusively or preferentially with lending affiliates.
CHLA Action Plan for GSE Reform
1. The GSE Profit Sweep Should End – Treasury should put profits into a Capitalization Reserve Account, to provide both a short term loss reserve and a long term capital source to ensure the GSEs’ continued critical role as a reliable Cash Window for smaller lenders.
CHLA was pleased that Johnson/Crapo included a number of provisions aimed at preserving a cash window for mortgage lenders that cannot directly access MBS securitization – including a provision that the initial capitalization of a mutual cooperative to provide a cash window would be funded through GSE profits. In practice, unfortunately, these profits continue to be swept, and therefore are not being retained for a later recapitalization of a cash window entity – whether it be the GSEs or a mutual cooperative.
CHLA draws two conclusions from this development. First, the continued failure to set aside funds for a de novo mutual cooperative calls into question the viability of such an approach to meet the cash window needs of small and mid-size lenders in a reformed housing finance system. Thus it appears increasingly clear that the only reliable approach to ensure that an effective cash window will continue to exist is for Fannie Mae and Freddie Mac to survive and to continue to perform this critical function.
Secondly, it is unclear how even Fannie Mae and Freddie Mac can be recapitalized to play this role, much less other functions it might carry out in a reformed system, as long as the Sweep continues. Therefore, on April 9, 2015, CHLA wrote Treasury Secretary Lew to recommend that funds now swept under the Sweep Agreement instead be set aside into a Capitalization Reserve Account – to be used to later capitalize a cash window (which CHLA now believes should be Fannie Mae and Freddie Mac).
Additionally, establishment of such a reserve account (or alternatively just ending the Sweep and having the GSEs retain their profits) would protect Fannie Mae and Freddie Mac (and ultimately taxpayers) from running out of funds if there is a short term loss at a later date. Moreover, it would be highly misleading to continue to sweep the GSEs’ profits for years, and then characterize an advance of funds due to a short term loss as a “bailout.” And it would be bad for consumers and mortgage markets if the use of the term “bailout” was used to justify a retrenchment of the GSEs’ role in providing access to mortgage credit.
Finally CHLA also believes it is important to clarify that any Congressional provisions that might limit authority to dispose of GSE Preferred Stock not be interpreted in any way as limiting the authority of Treasury and the FHFA to modify the Preferred Stock agreement to end the Sweep Agreement – or to set aside funds for later recapitalization of the GSEs, as CHLA recommends.
2. Congress should direct the FHFA to develop a plan to show how the GSEs could be recapitalized, and whether it recommends doing so.
CHLA supports recapitalization of the GSEs – but recognizes there are disagreements over this issue. Nevertheless, after 7 years of conservatorship, there is a significant danger of continued drift if both Congress does not act and if FHFA does not fully explore conservatorship options.
Therefore, CHLA believes it is time for the FHFA, as conservator, to develop and present a recapitalization plan for Fannie Mae and Freddie Mac. In fact, CHLA believes that Congress should direct it to do so – for example, no later than September 6, 2016, the 8-year anniversary of the GSEs’ conservatorship. Submission of such a plan need not pre-judge the ultimate resolution of this issue; FHFA could also be required to make a recommendation on whether to implement such a plan, and to include submission of other viable options. While it is reasonable for Congress to continue to assert its right to be the ultimate arbiter of housing finance reform, it should also debate the issue with all the facts – including maximally understanding what recapitalization of Fannie and Freddie might look like.
3. GSEs Should Control “Up-Front” risk sharing pilots, with protections against market concentration, including bans on volume discounts and bans on securities firms doing risk sharing MBS from dealing preferentially with bank affiliates.
Risk sharing can be a positive tool to reduce both GSE and taxpayer risk, to bring more private capital into mortgage markets, and to impose market discipline into the setting of underwriting standards. The GSEs have started doing this, with pilots to sell off risk on existing mortgages.
CHLA could support Congressional mandates for GSE “up-front” risk sharing – but only if it is secured and controlled by the GSEs. Without this safeguard, up-front risk sharing (either loan level or MBS) that is initiated and controlled by mortgage originators could result in market concentration for federally guaranteed mortgage loans. Big banks could use market size or securities’ affiliate capabilities to gain an unfair pricing advantage in mortgage origination – creating market concentration and resulting in fewer consumer choices and higher prices.
And these types of anti-competitive practices related to risk sharing should be prohibited. G Fee parity becomes less significant and risk sharing parity more so as the latter takes on more of the risk. Thus, providers of risk sharing, such as private mortgage insurers, should also be subject to “G Fee parity” – ie., prohibited from providing volume discounts. [Note: volume discounts differ from pricing differentials based on the risk of the borrower or the loan]. And securitizers should be prohibited from bootstrapping their role in providing risk sharing through MBS securities transactions where their investors take this risk to offer loans exclusively or on preferential rates and terms to their bank affiliates originating loans.
4. FHFA should complete work on a Common Securitization Platform (CSP) and Single Security– but should not turn over the CSP (developed at taxpayer expense) to Too-Big-To-Fail bank/securities firms.
CHLA supports continued development by the FHFA and the GSEs of a Common Securitization Platform, including Congressional requirements to do so. This is needed to facilitate non-discriminatory and affordable access by all mortgage lenders to the secondary market for federally guaranteed mortgage loans. Since taxpayer resources have gone into the development of the Platform, CHLA does not support any Congressional action to allow it to be used for private MBS by the biggest bank/securities firms – the very same parties that developed and securitized deficient subprime MBS and that played a major role in the 2008 housing crisis. The CSP’s role should be to facilitate qualified federally guaranteed mortgage loans, which serve the affordable mortgage credit needs of moderate income borrowers. Congress would still have the option at a later date to turn over the CSP to private parties as part of a broader housing finance reform bill – but to authorize this now is at best premature, and in CHLA’s view, unwarranted.
5. Federal Home Loan Banks should not use an explicit or implied taxpayer guarantee for MBS unless all mortgage lenders, including non-banks, can participate on a non-discriminatory basis.
CHLA was concerned that Johnson/Crapo permitted Federal Home Loan Banks to securitize federally guaranteed MBS – including potentially as the primary Cash Window – without serving non-bank mortgage lenders. Therefore, CHLA believes that FHLB securitization of guaranteed MBS should be prohibited unless non-bank mortgage lenders can participate on a non-discriminatory basis.