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Broken Home Finance System Due for Major Revamping
With Fannie Mae and Freddie Mac now in conservatorship and the housing finance market in turmoil, housing finance experts participating in an Oct. 27 NAHB webcast offered markedly different proposals for revamping the regulatory structure of the government sponsored enterprises (GSEs) and defining what new role they should play in supporting mortgage market liquidity and addressing affordable housing needs.
The only unanimous conclusion was that the status quo cannot be maintained.
“The question is how to make the transition from the current structure to the future structure without undermining ongoing financial rescue efforts and throwing the housing finance system into even more chaos,” said NAHB Chairman Joe Robson, moderator of the event.
“There are many possibilities, ranging from extremes, such as complete privatization or operation as government agencies, to a number of public-private versions between those extremes,” Robson added. “NAHB wants to go to the table with sound ideas that will produce the best possible long-term outcome for home buyers and home builders.”
Spinning Off Fannie and Freddie
Declaring that the current mortgage market is “not functioning,” Lewis Ranieri, CEO and president of the private investment firm, Ranieri Partners, LLC, said that it is imperative to re-establish a market-based system while addressing the problems that caused Fannie Mae and Freddie Mac to become “wards of the state.”
To respond to the needs of the capital market and improve the distribution of mortgage credit, his solution is for the government to spin-off Fannie Mae and Freddie Mac into new entities.
“I would take Freddie and use it in a co-op manner, by having it owned by the Federal Home Loan Bank System,” he said. “Therefore, the Bank System and its member institutions would be stakeholders and risk would be shared and backed with a government guarantee.”
Fannie Mae, he suggested, should be restructured as a public utility to purchase mortgages and bundle them into securities with a credit guarantee backed by the federal government. It would, however, only be allowed to hold modest amounts of mortgages and related securities as investments, and could only borrow at a market rate of interest.
Moving forward, the government can then take a look at which of the models is working best.
Bringing Back Private Investors
The Mortgage Bankers Association (MBA) in early September unveiled a proposal designed to ensure mortgage market liquidity in both good times and bad without presenting unnecessary risks to the taxpayer.
To bring private investors back into the market, the MBA proposed creating privately capitalized mortgage credit-guarantor entities (MCGEs) that would buy, package and securitize loans. They would operate under the auspices of a strong regulator to ensure they would remain functional even during times of market duress.
“An explicit government guarantee would be necessary because we believe that many private investors will not re-enter the marketplace if they have to take a credit risk,” said Michael Berman, president and CEO of CWCapital and chairman-elect of the MBA.
Under MBA’s proposal, the government securitization guarantee would support only “core” mortgage products such as 30-year and 15-year fixed-rate loans with well-understood, well-documented risk characteristics.
As for what impact MBA’s proposal would have on the multifamily mortgage market, Berman said: “We believe that the multifamily mortgage involvement of MCGEs is a critical element. At a time when 90% of multifamily financing is being shouldered by Fannie Mae and Freddie Mac, we believe that a permanent solution would incorporate those businesses within the MCGEs.”
To make the MBA’s proposed framework for a refined government role in the secondary market acceptable on Capitol Hill, Berman said the MCGEs would pay risk-adjusted premiums into a federal insurance fund each time they issued securities.
During this transition, Berman added that Fannie Mae and Freddie Mac would need to remain as functioning entities and continue to provide financing to prospective home owners on a long-
term basis.
Privatizing Fannie and Freddie
Taking a contrarian view, Peter Wallison, Arthur F. Burns fellow in financial policy studies at the American Enterprise Institute and an outspoken critic of the GSEs, said any plan that seeks to place Fannie Mae and Freddie Mac under a new government-sponsored or government-backed housing structure would result in the same serious financial problems that caused the two housing finance entities to be placed under conservatorship just over a year ago.
Wallison advocates privatizing Fannie Mae and Freddie Mac and ending the government backing for the secondary mortgage market.
“Fannie and Freddie are no longer going concerns. The government has to take their bad mortgages off their balance sheets,” said Wallison. “We ought to use the conforming loan limit as a way of re-introducing the private sector to the secondary mortgage markets.”
Protecting the Federal Home Loan Banks
Meanwhile, the Federal Home Loan Banks (FLHBs) have had far less difficulty and continue to operate outside of direct government control. But because of the problems with Fannie and Freddie, the regulatory system for the GSEs was overhauled, and they are all now under the oversight of a single regulator, the Federal Housing Finance Agency.
Geoff Bacino, who formerly served as a director of the Federal Housing Finance Board (the former regulator of the FHLBs) and is now president of Bacino and Associates, cautioned that “being painted with the same regulatory brush as Fannie and Freddie leaves the FHLBs in a tenuous situation.”
Calling on NAHB to urge Congress to “protect the FHLB franchise,” Bacino said that the biggest roadblock facing the FHLBs may be a lack of political support.
“The FHLBs need to convince Congress they are an essential part of the future finance mission,” he said. “As NAHB moves forward, you might ask yourselves what can be done.”
Heavy Lifting for Congress
It is difficult to predict just when Congress will take up GSE reform, said former House Financial Services Committee Chairman Michael Oxley, currently with the law firm of Baker Hostetler.
“GSE reform is one of the most difficult issues that I’ve ever dealt with in my 25 years in Congress because there are so many moving parts,” he said. “My old committee is up to their eyeballs in regulatory reform. Once major efforts at regulatory reform are completed, I would hope that GSE reform would not be that far behind.”
Oxley added that “there is no clear solution. There are no votes for nationalization; liquidation depends on how you do it. Privatization in a Democratic Congress and Administration? I don’t think so.”
Turning to the issue of a secondary market for jumbo mortgages, Berman said it will take time to resuscitate this sector.
“Investors need to be confident that a loan they make at 80% loan-to-value today will be a 75% to 80% LTV tomorrow,” he said. “Stabilization in single-family homes is another critical component. We need the economy and home values to stabilize and investors to have confidence in the rating system. It will take awhile.”
Explicit Government Backing
Panelists were divided on whether the federal government could ensure mortgage market liquidity and stability in a future financial crisis if the GSEs were to be privatized.
“If we develop a system in which the securitization market is back, then it is perfectly possible for the private sector to take over the secondary mortgage market without a crisis developing, just as no crisis results when credit markets handle credit card receivables,” said Wallison.
However, Berman cited previous financial crises, such as the 1998 Russian financial tumult that wreaked havoc on the global community and left Fannie Mae and Freddie Mac as the lenders of last resort after liquidity dried up in the U.S. mortgage markets.
“Our belief is to get through those times of economic stress and keep mortgage rates down for home buyers, we need explicit government backing to make sure the situation does not lead to distortions in the market,” said Berman. “The best of both worlds would be government involvement in a private-public partnership that will keep liquidity in the market during times of stress.”
Wallison and Berman also disagreed on whether mortgage interest rates would rise when the Federal Reserve discontinues purchasing Fannie Mae and Freddie Mac mortgage-backed securities, which could occur after the first quarter of next year.
“I’m puzzled why the Fed has to keep buying securities to keep rates down,” said Wallison.
“The Fed has been buying between 80% and 90% of Fannie’s securities,” said Berman. “At some point, private investors will come back in. The question is what extra spread is needed to get them back. It is unlikely to be 25 basis points. Is it 50 or 70? No one knows. We need to re-establish price in the private market in a delicate way.”
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