Agencies Scuffle Over Best Way to Make Loans More Expensive

<pThernOffice of Inspector General (OIG) of the Federal Housing FinancernAgency (FHFA) has expressed some skepticism about FHFA’s plans torngradually raise the guarantee fees (G-fees) of Freddie Mac and FanniernMae in an attempt to lure private investors back into the housingrnfinance system. In a report issued earlier this week, the OIG looks at thernmethods the two government sponsored enterprises (GSEs) used in thernpast to determine frees, the recent history of G-fee increases, andrnhow FHFA will determine if their private sector goals are reached. </p<pInrn2012 the GSEs generated $12.5 billion in revenues from thernsingle-family G-fees they charge to protect investors in theirrnmortgage-backed securities (MBS) against potential credit losses. FHFA has argued that the federal financial support for the GSEs hasrnallowed them to set their fees artificially low, increasing theirrnrisks and pricing competitors out of the market. FHFA has directedrnthem to increase fees so as to encourage greater private sectorrninvestment in mortgage credit risk, lessen taxpayer risk, and reducernthe dominant position the GSEs hold in housing finance.</p<pAtrnthe same time the Federal Housing Administration (FHA) under thernsupervision of the Department of Housing and Urban Development (HUD)rnhas raised its insurance premiums several times in recent years alsornin part to encourage private sector investment. However FHA has nowrnannounced it is discontinuing further premium increases.  OIGrnconducted its evaluation to analyze FHFA’s initiative and to assess its communications and interactions with FHA on theirrnFHA’s initiatives.</p<pThernGSEs use several methods in setting their guarantee fees. First,rneach employs a proprietary financial model to detrmine the creditrnrisk by modeling the rate at which the underlying mortgages willrndefault and the average losses on those that do (the loss severityrnrate.) If a GSE can reliably model the default and loss severityrnrates in a particular MBS set then it can estimate the credit riskrnand set an appropriate guarantee fee. The GSEs also employ theirrnfinancial models to ensure that the fees are sufficient to coverrntheir capital and administrative costs and certain other items.</p<pThernGSEs also rely upon business judgment in setting fees. They considerrnfactors such as competitive market conditions, return on capitalrntargets, and affordable housing goals. Freddie Mac told OIGrninvestigators they also have traditionally considered the financialrnmarkets’ view that Fannie Mae’s MBS offer superior liquidity to theirrnown and have attempted to provide financial incentives (i.e. lowerrnfees) to compete in the market.</p<pOIGrnsaid these methods aside, FHFA and others have argued that federalrnfinancial support for the GSEs has allowed them to set theirrnguarantee fees lower than otherwise would have been the case becauserngovernment support pre-conservatorship allowed the GSEs to issue debtrnat levels only slightly higher than those charged by the U.S.rnTreasury on securities with similar maturities. This ability tornissue debt at favorable rates has continued under thernconservatorships.</p<pFHFArntold OIG that this preferential support allows the GSEs to pricerntheir products and services, including MBS guarantee fees, at ratesrnlower than would otherwise be feasible for a profit-motivated entity,rnprovided them with an advantage over competitors that has allowedrnthem to dominate the housing finance system and amplified their risksrnbecause the fees did not fully reflect the potential credit losesrnthey would ultimately incur in fulfilling their commitments to MBSrninvestors.</p<pOIGrnfound that during the housing boom of 2004-2007 the GSEs' guaranteernfee rates were too low to mitigate the risks associated with theirrnmortgage purchase and securitization practices and ultimately thernlosses on the GSEs’ combined single family MBS guarantee businessrnreached $218 billion. These losses exceeded their available capitalrnof about $78 billion at the beginning of the conservatorship by arnfactor of about three to one. Starting in late 2007 the GSEs startedrnto increase the fees to better protect themselves against creditrnlosses and this trend has continued under the FHFA conservatorship.</p

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FHFArnandrnEnterprisernofficialsrnhavernprovidedrnseveralrnreasonsrnforrnthernlowrnguaranteernfees</bsetrnduringrnthernhousingrnboomrnyears.rnThey have said that the financial models severely underestimated thernrisk from Alt-A and other mortgages and failed to predict the drasticrndecline in house prices when the housing bubble collapsed. They alsornconcede that the guarantee fees were sometimes lower than called forrnby the financial models and were sometimes based in part uponrnbusiness decisions to make the GSEs competitive with private lablernmortgage-backed securities (PLMBS) issuers.</p<pThernGSEs nearly doubled their combined average G-fees to 50 basis pointsrnin 2012 due to a legislative mandate and a directive from FHFA. Inrnan attempt to raise federal revenue, the TemporaryrnPayroll Tax Cut Continuation Act of 2011 requiredrnFHFA to increase the gees by not less than 10 points, then FHFArnrequired the GSEs to increase fees by 10 basis points as part of anrnoverall plan to increase private sector investment and gradually endrnthe GSEs’ dominance in the housing finance system. </p<pFHFArnhasrnstatedrnthatrnraising fees is consistentrnwithrneffortsrnbyrnCongressrnandrnthernAdministrationrntornreformrnthernhousingrnfinancernsystemrnand many such proposals callrnforrntherneliminationrnofrnthernGSEs inrntheirrncurrentrnformrnandrntheirrnreplacementrnwithrnarnnewrnstructure.rn FHFA'srnproposalrntorngradually downsizerntheirrnmarketrnpresencernappearsrntornbernanrnattemptrntornprovidernarnfoundationrnforrnwhateverrnstrategyrnisrnultimatelyrn adopted.</p<pTornthis end the agency says it will continue to direct the GSEs torngradually increase the fees. However,rnOIG says,rnitrnisrnnotrnclearrnhowrnmuchrnhigher</bfeesrnwillrnhaverntorngorninrnorderrntornincreasernprivaternsectorrninvestmentrnnor has FHFArndefinedrnhowrnitrnwillrnmeasurernit. ThisrnraisesrnthernlevelrnofrnuncertaintyrnassociatedrnwithrnthernAgency'srninitiative.</p