DeMarco Determined to find Just the Right Amount of "Skin in the Game"

The actingrndirector of the Federal Housing Finance Agency (FHFA) discussed the future ofrnthe government sponsored enterprises Freddie Mac and Fannie Mae (the GSEs) onrnMonday, focusing on the future of single family guarantee business andrnhighlighting briefly the need for change in the putback risk loan originatorsrnface when selling mortgages.  </p

Edward J. DeMarcorntold an audience attending the 100th Mortgage Bankers Association conventionrnand expo that representations and warranties or reps and warrants have longrnserved a key risk control mechanisms for the GSE’s, helping to ensure that loans sold tornthem meet the requirements set forth in theirrnseller guides.  They attracted less attention when times wererngood but the tremendous breakdown in origination quality during the housingrnboom led to unprecedented delinquencies which led in turn to unprecedented loanrnreviews and putbacks. </p

DeMarco said thatrnas conservator of the GSEs, FHFA believes that enforcement of long-standing contractualrnrequirements was a necessary if painful process to protect taxpayers and assignrnlosses appropriately.  But the experiencernhas also demonstrated the need for improved quality control including betterrnuse of technology to enhance that control. rn</p

Earlier this yearrnhe promised that the GSEs would first of all complete all rep and warrantrnclaims on pre-conservatorship loans by the end of this year and the GSEs are onrntrack in this regard.  Second, the qualityrncontrol review process for all new production has been moved near the time ofrnpurchase rather than a later time such as when the loan becomesrndelinquent.  The period for whichrnthe reprnandrnwarrants remain active,rnexcept for limited issues such asrnfraud, is now limited to three yearsrnfor performing loans.</p

While importantrnchanges have been made to the rep and warrant framework there is still arnlearning process going on and further improvements should emerge over time,rnespecially improved data systems and technological developments to contributernto faster and more reliable loan reviews. </p

Anotherrnarea of progress in wrapping up the pastrnis resolving securitiesrnlawrnclaims on private-label MBSrnwhich are somewhat analogous to thernrep and warrant issue and also need to be resolved.  FHFA has now settledrnfour of the eighteen outstanding lawsuits in this area and hopes to build upon those cases to resolve the pendingrnones.</p

DeMarco againrnstressed the “overarching goal” of reducing the market presence ofrnthe GSEs and that, as their conservator FHFA has three main tools to accomplishrnthat objective.  The first, risk sharingrntransactions, are important for reducing taxpayers’ long-term riskrnexposure.  FHFA has set a 2013 Scorecardrntarget for each GSE to achieve $30 billion in risk sharing using multiple typesrnof structures.  Both Freddie and Fannie arernon target with this goal and the transactions so far, including a new type ofrnmortgage security and laying off risk on private mortgage insurers have beenrnwell received by the market. </p

Goingrnforward he said he expects to seernwork done on other types ofrntransactions such as senior/subordinatedrnstructures for certainrnportions of the GSEs’ mortgage guarantees.  Alternativernapproaches will contribute to efforts to develop a securitizationrninfrastructure that is less reliant on the GSEs’rntraditional government-sponsoredrnenterprise securitization model.</p

Second,rnDeMarco said, guarantee fees</bare about double what they were prior to conservatorship.  A key reasonrnfor this is to price credit risk closer to what would be requiredrnby private sectorrnproviders. While that levelrnis difficult to evaluate with precision, the fees are thought to be getting closerrnto a level that would encouragernmore private sector participation and future increases will berngradual in nature. </p