GSE reform is happening: Are people paying attention?
The disagreement on what comes next
March 8, 2016
Congress recently adopted so-called government-sponsored enterprise “Jump Start” legislation. Since the bill actually restricts actions to facilitate GSE reform, this is somewhat of a misnomer. But the goal is understandable. Congress wants to reserve to itself the right to make the big picture GSE reform decisions, like whether there should be a federal guarantee and whether and in what form Fannie Mae and Freddie Mac should survive.
But no one should be misled by the lack of comprehensive Congressional action into thinking that GSE reform is on hold. Fundamental reforms already have or are now taking place – reforms that reduce risk, protect taxpayers and build on lessons we learned from the 2008 crisis.
The most fundamental reform is loan quality. The GSEs would not have gone into conservatorship if they simply hadn’t made no doc (Alt A) loans and purchased MBS securities. With QM and strong underwriting standards, Alt A is a thing of the past. And GSEs have not only stopped making portfolio purchases, they are unwinding their existing portfolio holdings.
The second sea change is risk sharing. Almost all new GSE loan purchases now involve some form of risk sharing, also known as credit risk transfer.
Risk sharing significantly reduces GSE credit risk and imposes private sector market discipline. CHLA has concerns about how this is done; for example, an approach dominated by up-front securitization deals would hurt both consumers and small lenders, with the big banks potentially using securitization to create a choke point and control the market.
But risk sharing is now, as they say, the reality on the ground.
There is now a strong regulator – the Federal Housing Finance Agency. Everyone agrees the pre-Crisis regulator, Office of Federal Housing Enterprise Oversight, was too weak and timid. Since it took over in 2008, FHFA has required sound-underwriting standards, imposed higher servicer and mortgage insurer capital standards, and established a Scorecard to measure performance, including areas like access to credit.
Significant work has also gone into the development of a Common Securitization Platform. A CSP and common security would create a more uniform and competitive securitization market. For these reasons, CHLA opposes proposals by some in Congress to turn the CSP over to the big banks.
Finally, the model of “private gain, public loss” that characterized the pre-crisis GSEs is gone. When taxpayers stepped in to backstop the GSEs in 2008, they had received no premiums from previous years to cover the risk and cost of that action.
This is no longer the case. In fact, we have gone too far in the other direction. Under the Sweep Agreement, 100% of GSE quarterly profits are swept to taxpayers – and each GSE’s capital has been arbitrarily reduced to $1.2 billion today, going to zero in January 2018.
FHFA Director Mel Watt recently referred to the GSEs’ thin capital buffers as their “most serious risk.” Even a small non-cash accounting loss would precipitate a Treasury advance, which in the director’s words could “undermine confidence in the housing finance market.”
Such a manufactured crisis would be bad for consumers and housing markets. That is why CHLA recently joined with ICBA and CMLA in a letter to FHFA, asking for the FHFA to allow the GSEs to build up a modest capital buffer.
This is different from the broader issue of whether to fully recapitalize the GSEs. Unfortunately some opponents of the GSEs are characterizing any efforts to build capital as a return to the failed ways of the past.
As this article shows, that is a straw man argument. GSE reform has matured much further than most people realize – but there is disagreement about what comes next.
CHLA believes the FHFA, as conservator, should develop a capital plan to show how the GSEs could be recapitalized, including exploring options like a utility model. The result would a more informed Congress when it gets around to resolving the bigger issues that must be settled. Everyone would benefit from that.