Relegated to the back-burner for many years, talk of reforming mortgage giants Fannie Mae and Freddie Mac is back on the horizon.
Buoyed by the openness of the Trump Administration and a Republican-controlled Congress toward housing finance reform, several industry groups have presented new proposals for reforming Fannie Mae and Freddie Mac in recent months.
In April, the Mortgage Bankers Association released a 60-page white paper presenting a roadmap for restructuring Fannie Mae and Freddie Mac. The MBA’s plan calls for converting the government-sponsored enterprises to privately-owned utilities with regulated rates of return to its investors. The mortgage-backed securities issued by these entities would have explicit government-backed guarantees.
“Our paper does several things,” said David H. Stevens, CMB, president and CEO of MBA. “One, it resolves the structural and systemic mistakes of the previous model. It also creates a system for greater competition because it’s felt by many that this system of having just two companies with a protected right to a government guarantee creates almost a monopoly over market share, pricing, and innovation, and transparency to the consumer does not exist.”
Stevens cites the implicit government guarantee as a key factor behind the tumultuous 2008 housing crisis, since it led to misaligned incentives.
“The current Congressionally Authorized Charters provide a government backstop behind Freddie Mac and Fannie Mae,” Stevens said. “While they were creating good, traditional, 30-year fixed rate, documented qualified mortgages for borrowers, they were also buying negative amortizing loans, were very active in the subprime market, and those loans were also backed by the taxpayers. In our proposal, we place the backstop behind only the mortgage-backed securities, not the companies themselves, so that issue is eliminated.”
The MBA’s proposal also would:
• Enforce strong capital standards for the GSEs, comparable to those in place for so-called systemically important financial institutions (SIFIs);
• Re-charter the existing GSEs as “financial utilities,” owned by private shareholders, with a capped rate of return for investors;
• Protect taxpayers by putting more private capital at risk through expanded front- and back-end credit enhancements; and
• Ensure the availability of affordable housing.
As a former assistant secretary for housing and Federal Housing Commissioner at the U.S. Department of Housing and Urban Development in the Obama Administration, that last point resonates strongly with Stevens.
“The issue of affordable housing has not been addressed before by any industry paper,” Stevens said. “We wanted to ensure there is a duty to serve markets in a sustainable way, and that the new guarantor model will operate in a way that doesn’t just cherry-pick the highest credit quality borrowers. We think the guarantor should have the obligation to serve markets across the country, at all times.”
Other industry organizations have issued their own proposals for GSE reform. For instance, the Independent Community Bankers of America calls for change through both administrative and legislative means, an approach the group believes may have a higher likelihood of success.
On the administrative side, the ICBA calls for specific actions by the Federal Housing Finance Administration and the U.S. Treasury Department. These include working with the GSEs to implement capital restoration plans, and ending the so-called “net worth sweep.”
“The GSEs need to rebuild their capital buffers,” said Ron Haynie, senior vice president for mortgage finance policy at the ICBA. “[The FHFA’s] Director Watt said we’re going to reach a point here at the end of the year where they will have zero capital, an untenable situation that could put the housing market at risk. Our proposal calls for the development and submission of a capital restoration plan by the GSEs to the FHFA.”
The ICBA’s proposal also calls for an end to the net worth sweep, established in 2008 when Fannie Mae and Freddie Mac were placed under Federal conservatorship following the financial crisis. Under this program, the GSEs have made regular dividend payments to Treasury rather than shareholders, a factor that has contributed to their extremely low capital levels despite several years of profitability. The ICBA is seeking a delay in the development and launch of the common mortgage security platform until both GSEs are fully capitalized and released from conservatorship.
Legislatively, the ICBA calls for changing the GSE charter to a regulated financial utility, and transferring the implicit government guarantee on the GSEs to an explicit guarantee on the issued mortgage-backed securities. Both goals are similar to those in the MBA’s reform proposal.
Other industry players seek a different path toward reform.
Investors Unite advocates on behalf of a coalition of investors in Fannie Mae and Freddie Mac. According to the group’s website, recent bipartisan proposals in Congress are inadequate since they fail to push for government repayment of shareholders’ investments in the GSEs. Investors Unite also calls for stricter mortgage lending standards and the reinstatement of affordable housing initiatives.
Black Rock Inc., one of the nation’s largest mortgage bond investors, warned in a recent white paper against so-called “recap and release” proposals. These proposals call on the U.S. Treasury to quickly sell its shares in Fannie and Freddie after allowing the companies to build up capital. Black Rock argued that such moves could cause investors to lose confidence in the GSEs because “investors wouldn’t have confidence of the government backstopping the market in the event of a financial crisis,” according to an article in Bloomberg.com.
With both the Trump Administration and a Republican-led Congress actively discussing housing finance reform, many industry advocates believe something will get done this time around.
Stevens predicts the process will begin in earnest in late 2017, with additional Congressional hearings and the development of draft “straw man” legislative language. He believes the odds of legislation being passed sometime in Trump’s first term are very high, and may get done even sooner.
“There’s a reasonable chance for it to happen sometime in the next couple of years, but the window is towards the end of this year or early next year,” Stevens said. “You need to get it in early enough before the election cycle heats up so much that it becomes a challenging topic for anybody to take strong positions on.”
Haynie believes changes will occur first administratively through the FHFA and Treasury, while legislative changes could take a bit longer.
“I think the administrative reforms will happen in the very near future,” Haynie said. “[FHFA] Director [Mel] Watt has been raising the alarm about the capital buffer going to zero for a while now. I’m hoping he will take some action, if nothing else to at least rebuild the GSEs’ capital buffers to prevent them from having to take a draw for some quarterly operational issue.”
Freelance writer Ted Goldwyn contributed to the writing and research of this article.