Housing Finance: Credit Policies Dictate Private Demand

The Acting Director of the Federal Housing Finance Agency (FHFA)rnsaid this week that risk management is not the only relevant consideration in reformingrnthe nation’s housing finance system. </p<pEdward J. DeMarco, speaking to the 12 Annual Risk Management Convention,rnsaid, however, that the characteristics of the government’s role in housing andrnthe reform framework that is eventually put in place will define the degree ofrncertainty market participants have regarding their own risk exposure in housingrnfinance. </p

“The credit policies and guarantees put in place during the GSE reform process will ultimately dictate private investor demand for mortgage-backed securities”, says MND’s Managing Editor Adam Quinones. “That in turn will determine the level of mortgage rates relative to benchmark yields.” </p

Despite their conservatorship status, DeMarco said, therngovernment sponsored enterprises (GSEs) Freddie Mac and Fannie May remain atrnthe center of the country’s housing finance system, but that will have tornchange.  The longer the future structurernof the system remains uncertain, the more the operational risks of conservatorshiprnwill continue to emerge.   Improving and simplifying the operations ofrnthe GSEs is part of FHFA’s duty to preserve and conserve assets and is consistentrnwith the notion of their “wind down,” but the ultimate transformationrnof the GSEs and their market functions will largely depend on actions ofrnCongress and the Administration.  Thisrnleaves FHFA with the responsibilities of conservatorship while the long termrncourse is determined.  </p

DeMarco said it is important to keep the GSEs focused on theirrnexisting core business rather than venturing into new product lines orrnbusinesses but they must still looking beyond a holding pattern.  To this end FHFA is working with the GSEs tornmake long term improvements in the functioning of the system which will payrndividends without regard to the form the system ultimately takes.  For example, last May FHFA directed the GSEsrnto develop uniform standards for data reporting on mortgages andrnappraisals.  This will allowrnidentification of potential loan defects at the front end of the mortgagernprocess which should reduce repurchase risk. rnStandardizing terms and data reporting protocols will decrease costs andrnwill allow new industry participants to utilize industry standards rather thanrnhaving to develop their own proprietary systems. </p

More recently FHFA announced the Joint ServicingrnCompensation Initiative to consider alternative compensation models forrnsingle-family mortgage servicers.  Therngoals are to improve service for borrowers, reduce risk to servicers, providernflexibility for guarantors to better manage non-performing loans, and promoterncontinued liquidity in the To Be Announced mortgage securities market.</p

The White Paper on housing finance developed recently by thernDepartments of Housing and Urban Development and Treasury recommends a gradualrntransition to greater private capital participation in housing finance andrngreater distribution of risk to non-government participants.  While a lot of steps have been taken, thernWhite Paper envisions that FHFA will further strengthen the GSE’s underwritingrnstandards and improve the risk sensitivity of their pricing.  It also calls for a finding ways to bringrngreater private capital to the mortgage market such as increased down payments,rnexpanded private sector risk-sharing and further adjusting pricing to reflectrnwhat would result in a more purely private-sector operated market.</p

The Acting Director said that his agency’s statutoryrnresponsibility to “preserve and conserve the assets and property” ofrnthe GSEs leads to the question “what are we preserving and conserving,rnwhy, and for whose benefit?  The GSE’srnassets fall into four broad categories:</p<ul class="unIndentedList"<liThe legacy, pre-conservatorship book ofrnbusiness, including investments, mortgages owned, mortgages guaranteed;</li<liThe post-conservatorship book of new business.</li<liThe business platforms, operations, andrnprocesses;</li<liThe human capital; people who run the business, managernthe risk and support the operations.</li</ul

The “why” of doing this, DeMarco said it was tornprotect taxpayers from further losses, ensure market stability and liquidity;rnto give lawmakers options for the future, and to protect the future value ofrnthe GSE’s intangible assets for future utilization and value to taxpayers andrnmarkets.  “Even though we do notrnknow the future of the companies,” DeMarco said, “it makes no sensernto diminish, denigrate, or erode their tangible or intangible assets.”</p

FHFA must acknowledge the preserving and conserving thernassets entails many risk management challenges. rnThe legacy book of business must be protected from further credit lossesrnand FHFA and the GSEs are focused on effective loss mitigation strategies tornavoid foreclosure where practical and use loan modifications and other lossrnmitigation alternatives. </p

In managing the risk of the post-conservatorship book ofrnbusiness the challenge is establishing appropriate underwriting standards andrnrisk based pricing.  Much of this hasrnbeen done but further refinements will continue to be a challenge, especiallyrnsince government supported mortgage activity constitutes nearly the entirernmarket today.</p

There are multiple risk management challenges in the GSEsrnbusiness platforms, operations, and processes as shortcomings in those areas contributedrnto the conservatorship in the first place. rnIt is difficult to control for the future when the fate of the companiesrnis unknown; thinking about whether and how to invest in and develop infrastructurernand operations presents some unique challenges. rnDeMarco said participants need to continue to develop and maintain therninfrastructure supporting securitizations but some long term investments inrnoverhauling information technology or other infrastructure may not bernappropriate.  Finding the balance is key.</p

What may have happened with past management of the GSEs,rnDeMarco said is in the past.  Today it isrnnecessary  to address the uncertaintyrnfelt by GSE employees.  They know therncompany will probably cease to exist at some point yet there is critical workrnto be done.  FHFA has sought to establishrnan appropriate and competitive compensation system and while employeesrnappreciate both the importance of their role and being suitably compensated,rnthe opportunity costs to some will become greater over time.  Thus recruiting and retaining executives andrnstaff is one of FHFA’s principal risk management challenges.</p

There is also the issue of the public debates about the GSEsrnand their future and how those play out among employees.  DeMarco said Congress’s review of thernadvancement of legal fees to some officers was appropriate but also generatedrnuncertainty that commitments made to employees are subject to change ex post.  As conservator, he said, FHFA has anrnobligation to ensure these commitments are appropriate to the goals of thernconservatorship and are fulfilled to the extent FHFA’s authority permits.</p

Time, the Director said, is not on our side.  A lengthy transition is probably inevitablernbut we need to begin moving ahead now to determine the future of the nation’srnhousing finance system.  

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