Opinion by CHLA President Bill Giambrone – Blazing a Trail Through the GSE Jungle (July 2018)

Housing-finance reform doesn’t require hacking away the current system

This article appeared on Scotsmanguide.com – July 2018
By Bill Giambrone, president and CEO, Platinum Home Mortgage | bio
 In just two months, it will be the 10-year anniversary of the federal government putting Fannie Mae and Freddie Mac into conservatorship. This past April, Treasury Secretary Steven Mnuchin stated that the congressional action on reforming the two government-sponsored enterprises (GSEs) appears unlikely this year — and would more likely occur in 2019, when the new Federal Housing Finance Agency (FHFA) director is selected.
Many in Washington are very disturbed by Congress’ failure to act. They argue that only Congress can resolve the issues, and that its failure to do so could lead to a crisis. The reality is that Fannie and Freddie’s federal regulator — the FHFA — has already implemented a number of significant GSE reforms that should go a long way toward preventing a recurrence of the housing crisis.
What happened in the wake of the housing-market crash in 2008, and the panic caused by the near failure of Fannie Mae and Freddie Mac, shows how significant a role the housing industry plays in the U.S. economy. To prevent similar economic disruptions, mortgage originators should advocate for a smooth transition to an improved system that continues to reliably produce affordable 30-year fixed-rate loans for American homebuyers.
While Congress has not passed a comprehensive GSE reform bill, it has been engaged and arguably is generally supportive of the incremental reforms that have taken place to date. Instead of waiting indefinitely for Congress to pass a complex,  multi-hundred page reform bill, there is an administrative path forward with Congress as a partner in the process.
How we got here
Why did Fannie and Freddie go into conservatorship? There are numerous reasons. They purchased no-document loans; they bought risky mortgage-backed securities; they weakened credit standards and relied on inadequate underwriting documentation to try to maintain market share; and they maintained securities portfolios exposing them to interest-rate risk.
“ Instead of waiting indefinitely for Congress to pass a complex, multi-hundred page reform bill, there is an administrative path forward. ”
Since then, we have experienced 10 years of strong financial performance by Fannie Mae and Freddie Mac — which have now paid back their federal government advances and produced an additional $85 billion in profits for taxpayers. How was this possible? To a significant degree, it is because FHFA, under two different directors, has done a very effective job of reforming the way they do business.
No-doc loans are effectively a thing of the past — as a result of the adoption of the qualified mortgage rules that include a commitment to a verifying ability to repay, and because of improved overall credit management.
The purchase of risky mortgage-backed securities that got the GSEs into trouble also has been addressed by placing strict limits on the dollar amount of loans each GSE can hold in portfolio. This virtually eliminates interest rate risk and restores the GSEs to their core mission of facilitating securitization of qualified mortgage loans in the secondary market.
Through FHFA’s leadership, more than 90 percent of new Fannie and Freddie loans are now subject to some form of risk sharing, also known as credit-risk transfers. Risk sharing reduces taxpayer risk and imposes a form of market discipline through the involvement of private credit sources. Credit-risk transfer is working so well that Freddie Mac’s CEO, Donald Layton, let it be known this past May that the guarantee fees the GSEs charge lenders to cover potential credit losses on mortgage-backed securities (MBS) could possibly be lowered in the years ahead.
The federal role
As a consequence of the Housing and Economic Recovery Act of 2008, Fannie and Freddie now have an independent and respected financial regulator: the FHFA. This is a great improvement over the now-defunct agency that previously oversaw the GSEs — which was plagued by failures as a regulator and susceptibility to political influence. FHFA is there to make sure the GSEs do not go off a cliff.
Also because of the Recovery Act, the housing- goal process has been improved. Instead of a housing-goal approach that calls on the GSEs to stretch its resources to reach more low-income borrowers, the focus has shifted to comparative analysis of mortgage data to ensure the GSEs are not cherry-picking the highest credit-quality borrowers. There also is a duty to serve underserved but profitable markets, such as manufactured housing and rental housing. In addition, the GSEs make contributions to the Housing Trust Fund to address the toughest affordable rental-housing challenges.
The implied government guarantee of the GSEs has ended — and with it, the “private gain/ public loss” model. The federal role is now explicit (although it could be improved) — through a federal line of credit to the GSEs. And the GSEs are compensating taxpayers for that access to funding — with taxpayers receiving $85 billion to date in GSE net profits, after the GSEs repaid a 2008 federal advance.
“ For mortgage originators, it pays to focus on results more than process when it comes to GSE reform. ”
Finally, after years of debate, there appears to be a consensus on the need for a government backstop, in order to preserve an affordable 30-year fixed-rate mortgage. One need only talk with experts in the securities markets to confirm that some form of federal backstop is needed to efficiently access the national and international credit markets in order to ensure the liquidity exists to keep mortgages affordable for the full market.
Recapitalizing the GSEs
Why are the improvements to GSE operations to date important? Because they demonstrate that Congress passing a several-hundred-page GSE reform bill is not needed to put in place changes necessary to ensure the 2008 crisis does not repeat itself.
One critical reform remains unaccomplished. Almost no one in Washington questions the principle that large financial institutions should have adequate capital. FHFA recently took a good first step in allowing Fannie and Freddie to retain $3 billion each in capital, to cover small quarterly fluctuations in earnings. Late this past April, Fannie Mae’s first- quarter profits fully funded its $3 billion in reserves, and Freddie Mac funded two-thirds of its $3 billion reserve requirement.
It is, however, too much to ask Congress, which is best suited to addressing broad policy issues, to develop the details of a recapitalization plan for Fannie or Freddie — or even to determine the proper capital levels for these entities. That should be the responsibility of the two partners to the current GSE Preferred Stock Purchase Agreements — the Treasury Department and FHFA, which both have the needed expertise and the perspective.
The way forward
So what is the right path forward? First, Treasury and FHFA should work together to develop a detailed recapitalization plan for Fannie and Freddie that provides a credible glide path to reaching sensible capital levels and resolve how existing shareholders should be treated. Ideally, both agencies would commit to a timetable to release a specific proposal (and options, if appropriate).
Second, Congress should be vested in the process. It is not necessary for Congress to pass legislation to ratify any such proposal in order for a recapitalization plan to be carried out. But there needs to be buy-in from Congress, which, of course, can provide guidance or step in whenever it deems it appropriate to pass legislation. Congress should not be left out of the process, but it also must not bar FHFA or Treasury from acting if it does not have the will to act.
Third, Congress needs to resolve whether to authorize additional guarantors to compete with Fannie and Freddie. This approach is generally favored by the large Wall Street banks and large nonbank aggregators, but is generally opposed by groups representing smaller mortgage lenders as well as by consumer and affordable-housing groups, on the grounds that it would result in vertical integration, market concentration and ultimately less competition. Sen. Dan Sullivan, R-Alaska, pointed out at a recent hearing on internet and social media regulation that what happened with Dodd-Frank set the stage for empowering the big banks and cemented them as the dominant power. Do we really want the same with GSE reform?
Fourth, what Congress should codify — either now or in the future — are the important GSE reforms and policies that have taken place to date, in order to make them permanent. One such provision of critical importance to smaller mortgage lenders is guarantee-fee parity — a policy that FHFA instituted over the last few years. Volume discounts and other proxies for it that favor large lenders contributed to the crisis in 2008. They harm consumers and smaller businesses, and lead to a less competitive mortgage market. GSE guarantors should treat all lenders equally, regardless of size and mortgage volume — not just with respect to pricing, but also with respect to other issues — such as granting of variances and repurchase treatment.
Finally, for mortgage originators, whose goal is to serve borrowers, it pays to focus on results more than process when it comes to GSE reform. When in doubt, opt for a smooth transition, for flexibility, for reliance on practical solutions that have proven to work in the real world — practices judged on how well they serve borrowers and protect taxpayers, not on the size of the institution advocating them. The U.S. housing industry depends on reliable mortgage markets that continue to produce affordable 30-year fixed-rate loans for American homebuyers and homeowners. The best plan forward is one that puts that goal as the No. 1 priority.