More Details On New Mortgage Market Infrastructure, More G-Fees Too

Edward J. DeMarco, Acting Director ofrnthe Federal Housing Finance Agency (FHFA) appeared before the Senate BankingrnCommittee today.  According to hisrnprepared remarks DeMarco will tell the senators about the progress his agencyrnhas made in its dual role as conservator of the two government sponsoredrnenterprises (GSEs) Freddie Mac and Fannie Mae and as regulator of the FederalrnHome Loan Banks (FHLBanks.)</p

DeMarco briefly recapped the goals setrnfor FHFA as conservator and what has been accomplished to date.  </p<ul class="unIndentedList"<liThernoperations of the GSEs have largely stabilized while both mortgage originationsrnand securitizations continued to function throughout the financial crisis.</li<liThernfocus on foreclosure prevention efforts has been critical to helping homeownersrnin distress and essential to meeting the conservatorship mandate to preservernand conserve the GSEs’ assets.</li<liFHFArnhas clarified that the GSEs would be limited to continuing their existing corernbusiness and, while there is still legacy credit exposure to work through,rnthere is now in place loss mitigation infrastructure to help borrowers andrnprotect taxpayers.</li</ul

With these accomplishments FHFA hasrnmovedrninto a third phase ofrnconservatorship and its 2012 Strategic Plan presents three goals.</p

1.   Build a newrninfrastructure for the secondary mortgage market.</p

2.   Gradually contract thernEnterprises’ dominantrnpresence inrnthe marketplace while simplifying andrnshrinking their operations.</p

3.   Maintain foreclosure preventionrnactivities and creditrnavailability for new andrnrefinanced mortgages.</p

DeMarcornhas covered these three goals in previous House and Senate testimony and inrnnumerous public remarks.  A summary ofrnthe Strategic Plan from a 2013 perspective is available here along with a discussion of the proposed newrnsecuritization platform and uniform contracts which DeMarco also described inrndetail in today’s testimony.</p

DeMarco reviewed some recent FHFArnchanges which include a new streamlined loan modification initiative that willrnrequire servicers to automatically offer eligible delinquent homeowners an easyrnway to lower monthly payments and modify their mortgage even without providingrncomplete packages of documentation.  rnFHFA has also changed the representation and warranty framework forrnconventional loans sold or delivered to the GSEs.  These changes clarify lenders’ repurchasernexposure and liability and move the focus of quality control forward to therntime loans are delivered to the GSEs rather than at the occasion of default. </p

The second strategic goal set forrnthe conservatorship is to contract the GSEs’ presence in the marketplace.  As part of this FHFA has set a target of $30rnbillion of unpaid principal balance in credit risk sharing transactions in thernsingle-family credit guarantee business of both GSEs. To accomplish this thernGSEs are encouraged to consider transactions involving expanded mortgagerninsurance, credit-linked securities, senior/subordinated securities, andrnperhaps other structures.  The goalrnfor 2013 is to move forward withrnthese transactions andrnto evaluate the pricingrnand the potential for furtherrnexecution in scale.</p

DeMarco said FHFA expects to continue increasingrnguarantee feesrnin 2013 as a way to contract the GSEs’ market presence and encourage privaterncapital back into the market, not as a revenue measure.  He thanked senators for passing a resolutionrnprohibiting the use of these fees for non-housing related purposes.  </p

FHFA is setting a targetrnof arn10 percent reductionrnin new multifamily businessrnacquisitionsrnfrom 2012 levels.  This will probably bernachieved through some combination of increased pricing, more limited productrnofferings, and tightened underwriting standards. </p

DeMarco said FHFArnwas also setting a target of selling an additional five percent of the liquidrnportions of the GSEs’ retained portfolios above the 15 percent currentlyrnrequired by the revised Preferred Senior Stock Purchase Agreements.  DeMarco said that given natural run-off inrnthe portfolios they would likely have satisfied the PSPA reduction targets inrnthe next few years so requiring them to sell from the less liquid portions ofrntheir retained portfolios (delinquent loans and their own MBS) should lead tornan even faster reduction than required by the PSPA.  </p

DeMarco highlightedrnother priorities for FHFA in 2013.  Onernis the near-term efforts regarding mortgage insurance, updating master policiesrnby clarifying the role and responsibilities of carriers, especially whenrnservicers pursue loss mitigation to help delinquent borrowers and formulatingrnnew eligibility standards to ensure financial, operational, and managementrncapacity of the counterparties</p

Another project is the development of anrnaligned set of standards for forced or lender-placed insurance.  FHFA intends to address certain practicesrnrelated to this insurance including sales commissions received by sellers andrnservicers when placing and maintaining coverage with particular insurancernproviders through entities owned or controlled by the seller or servicer.  It also hopes to establish a set of standardsrnthat might be adopted by a broader set of mortgage market participants similarrnto what was done with the Servicing Alignment Initiative.</p

DeMarco saidrnthat while planning for the future, FHFA continues to fulfill its supervisoryrnrole with both the GSEs and the FHLBanks. rnThe agency has strengthened its supervision and oversight of GSErnactivities and, in the last year has put in place several changes that willrnallow it to quickly and effectively respond to emerging risks and developments.  In 2013 FHFA intends to:</p<ul class="unIndentedList"<liAssessrnthe risks posed by new initiatives, including the new securitization platform,rncontract harmonization, and multifamily and REO disposition programs, to insurernthey are being implemented under a sound control framework.</li<liMaintainrna fullrnunderstanding of the Enterprise'srnoverallrnrisk profile, particularly for the incrementalrnrisk created by implementing the new initiatives whilernmaintaining and upgrading information systems and internal controls.</li<liDetermine if thernboard and management are taking appropriate steps torncomply with conservatorship andrnsupervisory directives.</li<liDeveloprna formalized process forrnthe ongoing monitoring program.</li<liImplement the CAMELSO rating system.</li</ul

After recappingrnthe current financial condition of the GSE’s, both of which posted positive netrnincome in the most recent quarter, and the FHLBanks, DeMarco turned to thernissue of the future role of the government in housing finance and how largernthat role should be.</p

DeMarco thatrnwhile the role of government is ultimately up to the lawmakers, in his opinionrnthe main purpose of housing reform should be to promote the efficient provisionrnof credit to finance mortgages for single-family and multifamily housing.  An efficient market system for providingrncredit to people who want to buy houses should (1) provide consumer choice, (2)rnprovide consumer protections, (3) allow for innovation by market participants,rnand (4) facilitate transparency.</p

The size of government’s presentrnrole can be measured in several ways; the proportion of loans that arerngovernment guaranteed (65 percent), a flow basis (84 percent) or by securitiesrnissuance (over 90 percent.  “Howeverrnmeasured,”rnDemarco said, “it should be clear that today’s housing finance marketrnis dominated by governmentrnsupport.”</p

DeMarco said the question is howrndo we move from the market of today where almost all new single-familyrnoriginations have some form of government support to a future market far morernreliant on the private provision of mortgage credit.  </p

From the point of view of an economist,rnthe answer to the size ofrngovernment involvement begins with consideration of a potential marketrnfailure.  One type of failure might arisernif market participants have undue or unnecessary concerns about the ongoing stabilityrnand liquidity of mortgage credit in a purely private market across variousrneconomic environments.  If this viewrnprevails less credit will be provided than in the absence of this type ofrnuncertainty.  Government response in thisrncase could range from establishing standards and greater transparency for thernmarket, providing liquidity or credit support, or providing a guarantee tornlargely eliminate uncertainty.</p

Another potential marketrnfailure is the positive externality associated with homeownership.  In thisrnview, the benefits ofrnhomeownership extend beyondrnthernindividual household to thernbroader aspectsrnof society, i.e.rnthe opportunity to build family wealth, the willingness of homeowners tornimprove their property; hence if leftrnsolely to the marketrnthe number of homeowners willrnbe less than optimal.  A commonrngovernment approach to increase marketrndemandrnis to provide some type of subsidy or other assistance to encourage or facilitate suchrnconsumption.  Directrnsubsidies to lower the cost of mortgage creditrnor easing therneligibility termsrnfor arnmortgage are methodsrnof delivering subsidies throughrnthe housing finance market.</p

There seems tornbe relatively broad agreement that the model of providing private companiesrnwith benefits while expecting them to achieve public policy goals does not work.  The first option to this would bernto establish standards and rules for enforcing contracts that would provide arndegree of certainty to investors. rnInvestors would be required to price their risk and enforce their rightsrnunder standard contracts.  </p

The second optionsrnwould be to create a federal backstop that would preserve the availability ofrncredit in times of stress.  For example,rncould the Treasury Department, the Federal Reserve or the Federal Home LoanrnBanks play such a role in a market with a standardized framework?</p

The third optionrnis for a secondary market that would operate with some type of governmentrnguarantee somewhat similar to what exists today but one in which private sectorrncapital would stand in first loss position with a guarantee, funding through anrninsurance premium to cover additional losses.  </p

DeMarcornconcluded his testimony by saying that “few could have imagined in 2008 that we wouldrnbe approaching the fifth anniversary of placingrnFannie MaernandrnFreddie Mac inrnconservatorship andrnthat we have made littlernmeaningful progressrnto bring these government conservatorships to an end.”  They were never intended to be a long termrnsolution, he said, and the housing finance system cannot really get going againrnuntil Congress removes the cloud of uncertainty the conservatorship represents.

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