Here’s how to do it
CHLA shares plan for recapitalizing GSEs
This Op-Ed appeared in HousingWire on November 20, 2015.
It is now seven years since Fannie and Freddie went into conservatorship. The Community Home Lenders Association believes a government guarantee is needed to maintain an affordable 30-year mortgage and sustain housing markets. But consensus is elusive on what should come next.
In September, CHLA released a detailed plan for GSE reform. It preserves mortgage credit, protects taxpayers, and benefits consumers through market competition.
The plan: (1) ends the Profit Sweep that prevents the GSEs from building up reserves, (2) requires FHFA to develop a recapitalization plan for the GSEs, (3) provides protections under “up-front” risk sharing to prevent concentration of mortgage markets among the big banks, and (4) requires completion of the Common Securitization Platform.
Thus, CHLA was disappointed with Administration statements that actions like ending the Profit Sweep should wait for comprehensive Congressional legislation. The problem: almost everyone agrees this is not going to happen any time soon. Meanwhile, the Sweep Agreement appears to be leading inexorably to a day when a Treasury advance is needed.
So what should be done? First, there is consensus that a well-functioning housing system must have a cash window to facilitate smaller lender access to loans at competitive terms. The Johnson/Crapo bill that passed last year required a cash window. But it funded the cash window through the profits of Fannie and Freddie. This promise has already been broken, because of the GSE Profit Sweep.
CHLA believes the GSEs should be allowed to keep profits to build capital, to maintain their role as a cash window. They should also build up reserves as a buffer against losses. Freddie Mac reported a $3.9 billion profit in the second quarter. But when they lost $501 million in the third quarter, instead of using second quarter profits to cover the loss, their reserves were depleted because those profits had been swept.
Without reserves, the GSEs will eventually need a Treasury advance – and such a “bailout” may spur calls for the GSEs to pull back on mortgage credit. Housing could suffer.
Secondly, CHLA believes that the FHFA should develop a plan to recapitalize the GSEs. FHFA is their conservator, so it should be responsible for showing how the conservatorship could be ended. And Congress – when it finally acts – would be better informed how this could be done.
Third, a critical feature of the current system is the ability of small and mid-sized non-bank and bank lenders to securitize loans. This promotes competition and lower rates for borrowers. But this may be at risk as a result of the emergence of “up-front” risk sharing.
CHLA supports risk sharing – but is concerned about up-front risk sharing through securitizations by a few big vertically integrated bank/securities firms. These mega-banks could leverage risk-sharing securitization to generate funds to exclusively originate GSE loans through an affiliated bank.
There are already two such deals totaling $2 billion with JPMorgan Chase. If this becomes the dominant form of risk sharing, small and mid-size firms could be shut out of the process.
FHFA and the GSEs should be fully transparent about these risk sharing deals – and should ensure that small and mid-size lenders aren’t shut out – by banning practices such as volume discounts and stopping mega-banks from dominating both risk sharing securitization and underwriting of the loans they fund.
CHLA agrees that the old model of “private gain, public loss” must end. Reforms are needed, including: (a) an explicit (not implied) government guarantee, (b) G-fees commensurate with the risk of that guarantee, (c) risk sharing to reduce government loss and interject market discipline (d) basic underwriting guidelines for sound loans, and (e) sound financial regulation.
Not everyone agrees about the best way forward here. But after seven years in conservatorship and under government control, continued drift on GSEs should not be an option.