“HOUSING FINANCE UPDATE:  The Conundrum Continues…” by Barbara NovickrnVice Chairmanrnand Head; Kevin Chavers, Managing Director; and Alexis Rosenblum, Associate, describes the foundations of the recent recovery as fragile and say arnnumber of impediments remain:</p

Housing Activity:  The rebound has been spurred by investorsrnrather than homeowners and these cash buyers have substantially reducedrninventories.  If inventories rebuild itrncould put pressure on prices.</p

Structural impediments:  These include weak income growth, highrnunemployment, and the burgeoning student loan debt which has encouraged some tornabandon or postpone homeownership</p

Credit Constraints:  Due to tightened underwriting and thernregulatory concerns of lenders.</p

The recovery has featured an extraordinary level ofrngovernment support; with government behind almost 100 percent of newlyrnoriginated mortgage loans, and the government sponsored enterprises (GSEs)rnFannie Mae and Freddie Mac along with Ginnie Mae account for almost all new mortgage-backedrnsecurity (MBS) issues and the Federal Reserve’s monetary policy and mortgagernbuying program have been vital to the recovery. rn</p

Evenrnthough the consensus is the system must attract more private capital, in thern”absence of legislative reform,rnmultiple regulatory agencies continuernto forge ahead with piecemealrnefforts that are effectively altering the currentrnhousing finance landscape.”  Many policy initiatives to date have beenrnfragmented and in some cases “effectively discourage private capital fromrnthe sector,” the authors say.  Thernpatchwork of efforts “creates uncertainty andrnsuggests a lack of political will andrnpath to achieving a solution-oriented policy objective. There is concern about investors’ perception of policy riskrncaused by this lack of a clear andrnconsistent approach tornhousing policy.”</p

The article recaps many of the policy and legislativerninitiatives either underway or under consideration.</p

A recent report of the Housing Commission of thernBipartisan Policy Center (BPC)  proposed winding down andrneventually eliminating the GSEs over a number of years, replacing them with a government-owned corporation that would providerna “limited catastrophic government guarantee“. Option Three of the Obama Administrations 2011rnWhite paper is largely in agreement with the BPC proposal.</p

The Federal Housing Finance Agency (FHFA), conservator of the GSEs, is spearheading a host of initiatives under the umbrella of itsrn”Strategic Plan.”  </p<ul class="unIndentedList"<liA call for building a new secondary market infrastructure which the GSEs would jointly developrnand own. </li<liArnUniform Mortgage Data Programrnto enhance disclosures and allow thernmarket to better understand andrnultimately price and absorb additional creditrnrisk.</li<liArndirective to GSEs to steadily increase guarantee fees and actively evaluate other forms of credit risk dispersion; </li<liA call for anrnaccelerated disposition of "illiquid" assets heldrnin the GSEs' retained portfolios, </li</ul

In April FHFA directed the GSEs to extend the Home Affordable RefinancernProgram (HARP)rnby two years.  BlackRockrnsays HARP is an effective program but continued changes to its parameters havernheightened investors’ concerns about uncertainty and policy risk and mayrndiscourage private capital.  </p

In addition to the GSE reform initiatives being implemented by FHFA, regulatoryrnagencies are promulgating key rulemakings required by the Dodd-Frank Actrnincluding the “Ability to Repay” rule, the definition of QualifiedrnMortgage, Qualified Residential Mortgage, National Servicing Standards and thernRisk Retention Rule.</p

Finally, the reform of the credit ratingrnagencies pursuant to Dodd-Frank will also haverna material impactrnon the re-emergence andrnfunctioning of the private label MBS market.rnRegulators need to developrna clear understanding of how investors userncredit ratings and to establish agreement on the objectivesrnof credit rating agency reform,rnparticularly measures that increase transparency of data whilerndiscouraging measures that attack the fundamental businessrnof creditrnrating agencies.</p

The legislative focus of currentrnhousing finance policy isrnalso the reform and/or elimination of the GSEs.  A number of GSE-related bills havernbeen introduced in Congressrnover the past five years, however the authors say until recently most appeared to be political statements or “messaging” bills ratherrnthan practical and solutions-oriented.  Recently more comprehensive legislation has been introduced andrnPresident Obama has spokenrnpublicly about thernneed to reform the agencies. </p

All of this is complicated by thernrecent financial successes of the GSEs.  Their contributions to Treasury havernmaterially contributed to deficitrnreduction and, coupled with increasedrntax receipts, have helped delay thernneed to raise the debt ceiling.  Anotherrncomplication is the series ofrnrecent legal challenges by GSE shareholders and affordable housing groups regardingrnamendments to thernSenior Preferred Purchase Agreementrnby the US Treasury.</p

Given the importance of the GSEs, any reformrnmust include a clear planrnfor an orderly transitionrnto a new system thatrndoes not impair liquidity,rnpose a threat tornexisting investors or interferernwith the orderly functioning of this multi-trillion dollar marketrnor impair the its current recovery or long termrnstability. </p

Therernis also pending reform legislation.  The “HousingrnFinance Reformrnand Taxpayer Protection Act”, (the Corker-Warner bill) wouldrnreplace Fannie Mae and Freddie Mac with an entity called thernFederal Mortgage InsurancernCorporation (“FMIC”), a single government guarantor.  It would charge guarantee feesrnto provide a full-faith-and-credit backstop on mortgaged-backed securities (MBS) provided that a privaternguarantor took a 10%rnfirst-loss risk position.rn </p

The bill also proposesrnthat the FMIC establish a mortgagerninsurance fund, maintain a database of uniform loanrnlevel information on eligible mortgages, developrnstandard uniform securitizationrnagreements, and oversee the common securitization platform currently being developed by the FHFA.rnFannie Mae and FreddiernMac would be wound down over a period of time,rntheir assets availablernto the new entity. </p

Thisrnbill has garneredrnattention as the first bipartisan piecernof legislation addressing comprehensive reforms.rnHowever, Senate Majority LeaderrnHarry Reid recently questioned thernPresident’s recommendation to eliminate FanniernMae and Freddie Mac, so thernbill’s pathway to final passage remains uncertain.</p

Jeb Hensarling, Chair of thernHouse Committee on Financial Services has introduced a bill entitled “ProtectingrnAmerican Taxpayer and Homeowners Act” (the “PATH Act”rn) which seeks to attract more private capital to the sector but calls for no future government support beyond arnreduced role for the FederalrnHousing Administrationrn(FHA). It would eliminate FanniernMae and Freddie Mac over a five year periodrnand accelerate the reduction ofrntheir retained portfolios. </p

PATH would also re-definernthe mission of FHA by limitingrnits support to first time and low-to-moderate income homeownersrnand reduce FHA mortgagerninsurance coveragernfrom 100 percent to 50 percent.  Thernbill calls for thernmaintenance of a privatelyrnowned securitization platform,rnseeks several changes to thernDodd-Frank housing requirements andrnto spur development of therncovered bonds market.rnFinally, the bill would prohibit a GSE or FHA from backing any loan in arnjurisdiction that utilizedrneminent domainrnto seize mortgages.  </p

President Obamarnrecently laid out four core principles for housingrnfinance reform:rn1) private capital should be at therncenter of the housingrnfinance system with arnmore limited role for government; 2)rnensure no more taxpayerrnbailouts byrnwinding down the GSEs; 3) maintainrnwidespread access to 30-yearrnfixed rate mortgages; and 4) support affordability andrnhomeownership for first-time buyers as well as accessrnto home rentals for those who cannot afford to buy arnhome. This is again similar to “Optionrn3” from the Administration’s 2011 paper. </p

The authors sayrnthey are encouraged by the Corker-Warner bill’s preservation of a full-faith-and-creditrnguarantee of securities andrnthe bi-partisan support for thernbill but it raises both substantive and politicalrnquestions; is there sufficientrnprivate capital available to assumernthe 10 percent first lossrncredit risk position?  Is that cushion excessive, givenrnthat Moody’s Analyticsrnviews 5 percent as more than adequaternto weather futurernfinancial storms?”   Assuming the 10 percent first lossrncapital cushion is available, is this likely to undulyrnimpair borrowers’ accessrnto mortgage credit and reducernliquidity, impeding recoveryrnand putting a substantive burden on future homeowners?  The billrnalso faces a number of political hurdles.</p

The PATH Act raises arnhost of questions as well. The elimination of any form of government guarantee would likely materially impair the availability and increase the cost of mortgage credit. The Hensarling Bill passedrnout of the House Financial ServicesrnCommittee on a straightrnparty line vote in July however most observers placerna low probability on it final passage.</p

The authors say they continue to believe that the retentionrnof a government guarantee is essential to any reformrnand that it is vital thatrnany major legislation provide clarityrnand certainty regarding the scope ofrnthe guarantee to bernprovided.  Moreover, an orderly transitionrnmust provide for fungibility of the existingrnGSE securities andrnany new securities that would result fromrnreform. These principles are vital to maintaining liquidity, without disrupting thernefficient functioning of the mortgage markets. Every housing financernreform proposal must be evaluated against thesernprinciples and the resultant impact on thernstability of the housing market.</p

The Federal Housing Administration is also targeted by reform otherrnthan that of PATH.  The FHA Solvency Actrnof 2013 recently voted out of the Senate Banking Committee would raisernthe minimum capital reserve ratio of thernMortgage Mutual Insurance Fund to 3 percent and givernthe Department of Housing and Urban Development (HUD) special tools to addressrnFHA’s failure to meet the goal. It would also increase minimum annual mortgagerninsurance premiums and reevaluate them annuallyrnto ensure they cover expectedrnrisk and maintain the capital reserve ratio.rnThis bill does notrnseek to reduce the insurance coveragernof FHA nor redefinernits mission like the PATH bill and the authors say they are somewhat more optimistic aboutrnits future. </p

The authorsrnsingle out two factors that they believe are singularly harmful to recovery andrnreform, especially the reentry of private capital. The first is the use ofrneminent domain as proposed in some localities to seized mortgages from MBS andrnrestructure them.  The second is thernNational Servicer Settlement.  Therneminent domain issue, the authors say, would have a profound impact on nationalrnhousing policy and global markets.  Theyrnsupport suggestions and the PATH legislation that would prohibit the GSEsrnand/or FHA from doing business within any locale that so utilizes eminentrndomain.   </p

The ServicerrnSettlement, they say, unwittingly allowed sanctions on servicers to be paid byrnprivate investors and the same construct has been adopted by the FederalrnReserve and the Comptroller of the Currency in their servicing settlementrnactions.  This will deter investors fromrnputting money at risk and is at cross-purposes with the public policy goal ofrnattracting private capital. </p

In conclusion the article saysrnthat while there are differingrnviews about the proper degreernof government support therernis an emerging consensus that any seriousrnapproach tornreform of the housingrnfinance system mustrnattract more private capital and reducernthe unprecedented levelrnof government support currentlyrnin place. The authors restate the need for a holistic, coordinatedrnapproach to reform rather than one that works at cross-purposes with the goalrnof attracting private capital.

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