Senate Witnesses Agree on Vital Components for Mortgage Reform

The panel ofrnfour witnesses that appeared before the Senate Banking Committee hearing on thernEssential Elements of Housing Finance Reform were largely in agreementrnregarding the essential outline and goals of that reform.  There was unanimity on the need for access,rnstability, and transparency and all agreed that any system that emerged shouldrnhave some mixture of private capital and a catastrophic government guarantee. </p

Jerome Lienhard II, President andrnChief Executive Officer, SunTrust Mortgagernsaid that from the prospective of a regional bank, the necessary reform of thernhousing finance system must retain the basic “plumbing” ofrna system that draws inrnenormous sums of investmentrncapital and provides borrowersrnwith rate certainty.  Reformrnmust bring more private capitalrninto the mortgage market in a principalrnloss position while maintaining arnglobal market for mortgage-backed securities (MBS) and providingrncompetitive access for smallrnand medium-sized institutions that serve millions ofrnhomeowners.rn</p

Lienhard said that while his bank has originatedrnand service more than $140 billion in mortgages, it holds only one in six orrn$30 billion worth on its books.  This isrnmade possible for SunTrust and other regional banks by the existence of thernsecondary market. </p

A bank must be able to give the customer<bbasic information on its interest rate and monthly costs up front, informationrnthe bank gets from the price of MBS trading in the “To Be Announced” (TBA)rnmarket.  The bank can then lock in the raternfor up to 90 days and proceed through the lending process,rnproperly qualifying, underwriting, documenting, and closing the loan.  But this all starts with the certainty of howrnthe bank is funding the mortgage without which lenders would have the “chickenrnor egg” problem of funding risk without knowing its price. </p

While there is arnneed to address taxpayer risk, Lienhard said, thernsecuritization platform, thernstandard-setting on lendingrnand documentation and thernservicing requirements are absolutely essentialrnto maintaining a secondaryrnmarket and we must emerge fromrnhousing finance reform with these key functions intact.</p

Richard Johns, Executive Director of the Structured Finance IndustryrnGroup (“SFIG”) also stressed the preservation of the TBA market and suggestedrnthree sequential stages that any reform effort should follow.    </p<ul class="unIndentedList"<liA conversion into a common TBA, making Fannie and Freddie MBS fungible and thereforerndeliverable into a single TBA Market,rneliminating current pricing and liquidity inefficiencies in the Agency Market.</li</ul<ul class="unIndentedList"<liThe creation of a single agencyrnsecurity to facilitate the conversion and continued liquidityrnof legacy securities and promote a deep and liquid new-issue MBS market.rn</li</ul<ul class="unIndentedList"<liEstablishmentrnof a common securitization platform for the purpose of overseeing and maintaining the standardization of the market for government-guaranteed MBS.</li</ul

Johns suggested that it should be left to regulators to determine thernspecific types of representations, warranties, enforcement provisions andrnrecourse to be used in the new system.  Hernalso advocated that government separate any goal of affordable housing from thernoperation of the secondary market, funding affordable housing through separaternlegislative mechanisms.  Also, reducingrnthe upper loan limits for government guaranteed loans would ensure that theirrnbenefits are directed to the populations most in need of them.</p

Julia Gordon,rnspeaking on behalf of the Center for American Progress (CAP), said that a consensusrnof stakeholders appears to be solidifying around the idea of a catastrophic governmentrnguarantee behind private capital such as is proposed in S 1217, thernWarner-Corker bill rather than the virtual elimination of governmentrninvolvement proposed in the House legislation called PATH.  Differences center on how to structure putting private capitalrnin a first-loss position.  </p

CAP, Warner-Corker, andrnothers have called forrnspecialized mono-line institutions or bond guarantors. Other plans envisionrnissuers that lay off therncredit risk through structuredrntransactions.  S. 1217 offers a plan throughrnwhich issuers could toggle between bondrnguarantors and a purely private capital marketsrntransaction.  The first alternative, Gordon said, is the only structure that meets allrnthe other requirementsrnCAP believes are necessary.  It is farrnmore likely to bernregulated and managed effectively forrnsafety and soundness as there will bernfarrnfewer bond guarantors than issuers.  The regulator would need extraordinary regulatory capacity or ironclad coordination with banking regulators to evaluate the safetyrnand stability of the many institutions involved in the structured transactions.</p

Second,rnbond guarantors are muchrnmore efficient at pooling and spreading risks. Structured transactions, to the extent that they coverrna singlernor limited number of pools, cannotrnallocate risks andrnreserves across years, regions,rnlenders, and so on.</p

Third, investors in structured transactions have proven unwilling to assume risk on anything but the most pristine mortgagesrnand if they are assuming first-loss position their high level ofrnscrutiny will result inrnhigher prices for non-traditional but credit-worthy borrowers.   rn</p

Individualrndeals are much less likely to bernable to supportrna robust TBA marketrnand, although the appeal ofrna structured transaction is that thernmoney is already thererntorncover losses, it is much harder tornascertain how the investor institutionsrnare accountingrnfor these assets on their own books and to prevent them exporting risk into the larger financialrnsector.  Finally, bond guarantorsrncan provide more protection to the taxpayer at less cost. </p

Gordon said sherndoes not believe the S. 1217rnapproach of offering both executions will work.  The currentrnbill tilts thernplaying field toward thernpure capital markets approach,rnsince that execution hasrnlittle by way of regulatory requirements and can more easily meet the capital thresholds through leverage. Moreover, allowingrninvestors to toggle back and forth between executions will likelyrnfragment the market sufficiently to underminernTBA.</p

Gordon alsorncalled for establishment of a Market Access Fund to ensure a new system has the<bcapacity to service borrowers in a "grey zone" between private credit and creditrnthrough VA, FHA, and USDA.  This would bernfunded through a 10 basis point assessment on all securitized mortgages, whetherrnor notrnan issue receives a federal guarantee. rnThe fee would be collected by the SEC and used to provide support forrndeveloping innovations geared to expanding sustainable homeownership, forrnunsubsidized affordable rentals, to provide limited credit support and providerngrants to encourage development of self-sustaining support services such asrnhousing counseling.  Gordon said estimates suggestrnthis fee wouldrnresult in approximately $5 billion in revenues by thernfifth year of generation.</p

Mark Zandi, Chief Economist and Co-Founder Moody’s Analytics laid out a nearly completernblueprint for revamping the system including the same goals of access andrntransparency outlined by others but in many cases his recommendations were muchrnmore specific.  </p

To achieve these goalsrnZandi said the future housing financernsystem should embody a number of essential elementsrnincluding a catastrophic government backstoprnwith private investors providing the first loss capital. He refers to this as arnhybrid housing finance system. </p

A substantial amount ofrnfirst-loss private capital should stand in front of the government’s catastrophic backstop.  Losses suffered in the Great Recession shouldrnbe the benchmark.  Freddie Mac and FanniernMae (the GSEs) and private mortgage insurers ultimately had a combined lossrnrate of between 4 and 5 percent.  This, whatrnZandi called the 100-year flood mark, would be a conservative capitalizationrnrate since regulations will require guaranteed mortgages to be of higherrnquality than those purchased by the GSEs. </p

The private capital that willrnbear risk ahead of the government should come from varied sources. At the loanrnlevel private capital shouldrninclude down payments from borrowersrnand the capital of any private mortgagerninsurers attached to the loan. At the MBSrnlevel sources should include the capital of the mortgagernguarantors, risk retention by mortgage issuers, and the capital put at risk by globalrninvestors who take on housing risk from mortgagernguarantors. </p

The system must be overseen by arnstrong regulator fashioned along the lines of the FDIC which would manage an insurance fund, funded by mortgagernborrowers, to pay for any future costs that the government bears backstopping the system.</p

A commonrngovernment-run securitizationrnplatform which would be used forrnall non-Ginnie Mae government-guaranteed securities and, although not required, could be usedrnfor nonguaranteed securities. </p

There should be a competitive mortgage guarantor market independent from large institutions that originate mortgagernloans.</p

Zandirnsupports a hybrid system as the most desirable option for reform and went intorngreat detail in his testimony has to how it should be structured, funded, andrnprotected.  His complete testimony andrnthat of the other witnesses is available here. 

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