From my partner, DCTripwire:
Debate on Housing Heats Up
Bottom Line: The recent conferences debating reform of Fannie Mae and Freddie Mac (the GSEs) and today’s release of the Financial Crisis Inquiry Commission’s Report and Dissents are making big headlines, but the real battles are being fought within the Obama Administration, among regulators over smaller related housing issues, and between Republicans in the new Congress. The next few weeks will show significant developments in some of these areas, but the process for reforming the GSEs and the housing finance system more broadly, lags far behind the deficit and job creation in the minds of Congress and the Obama Administration. Look for this battle to take years, not months, dragging out the uncertainty and sclerosis which has plagued the housing markets for the past several years.
This update will cover three housing-related areas:
1. Obama Administration Proposals for GSE/Housing Finance Reform
2. Regulatory Efforts to Reform Housing Finance
3. GSE Reform Efforts in Congress
Obama Administration Proposals for GSE/Housing Finance Reform
- The Obama Administration has leaked reports to the press that their report outlining suggested reforms to Fannie Mae and Freddie Mac, will be delayed till mid-February, from the statutory due date of January 31.
- Likely causes of this delay are twofold: a lack of senior staff at Treasury and the Federal Housing Finance Agency (FHFA)—the same team that is responsible for implementing many of the rules and regulations of the Dodd-Frank Act are also in charge of GSE reform, and the fact that there is a split within the Administration, both substantively and politically on any reform efforts. One side is determined to maintain some sort of government (and hence taxpayer) guarantee of mortgage securities, providing support of middle class homeowners. The other side seeks to remove the government from having either an explicit or even implied guarantee and instead hopes to trade this removal of the government from the market for the creation of a fund to assist low-income citizens in attaining affordable rental housing.
- Secretary Geithner (and former National Economic Council Director Larry Summers) are in the former group, while Housing and Urban Development (HUD) Secretary Shaun Donovan and other progressive members of the Administration are in the latter.
- It seems clear that in the current climate of fiscal austerity, there is little possibility of establishing any new on-budget program for affordable housing, or even sustaining the HUD budget at present levels. This fact, coupled with the potential for an overall shift by the Administration back towards the political center, will likely mean that the report, whenever it is issued, will maintain some government role in the mortgage market.
- The report will also likely spell out several options for housing finance reform, in very broad terms, and will not be in legislative language. The Administration wants this report to add to the discussions on this matter, but is widely expected, for political reasons, to allow Republicans in the House of Representatives to launch the first salvo in this legislative battle.
Regulatory Efforts to Reform Housing Finance
- Despite the lack of concrete action by the Administration, there are several regulatory actions that are being discussed or implemented at present.
- The first actions have been taken internally by Fannie and Freddie. They each have improved their balance sheets since conservatorship began. Credit standards have been raised, and both GSEs are refusing to purchase mortgages from borrowers with poor credit scores. Fees that each entity charges to banks to guarantee their loans have also been increased and this income has helped to rebuild their balance sheets.
- Both GSEs still owe a substantial quarterly payment to the Treasury Department in the form of a 10% dividend on the Treasury’s preferred stock. If this dividend was lowered, it would allow the GSEs to begin to repay the billions in taxpayer support and simplify any future restructuring.
- Any change to the dividend would need to be approved by both Treasury and the Federal Housing Finance Administration (FHFA) which is the GSEs conservator. Expect that any changes will be subjected to heavy Congressional scrutiny.
- Another move that the GSEs and the FHFA are contemplating is a shift in the ways that servicers are compensated. According to a joint FHFA and HUD announcement, a joint study is being made of future mortgage servicing structures and compensation for single-family conforming mortgage loans. Servicer compensation at present is based on a minimum servicing fee that is included in the mortgage rate, and thus decreases the flexibility of servicing non-performing loans, which has the potential to affect negatively both borrowers and guarantors.
- New proposals may include separation of servicing compensation from the mortgage rate, introducing variable compensation based off of performance in managing and working out non-performing loans, or even reducing or eliminating fees on performing loans. The goal of any proposal would be to improve the process for both home-owners and mortgage investors.
- A proposal on this topic is expected in several months, but any implementation of a new servicing compensation model through regulation alone, would not occur before summer 2012. It is important to note that absent any substantive reform of the GSEs, servicing changes that are adopted by Fannie and Freddie will effectively become the new standard for the whole housing finance industry.
- Additionally, a joint Office of the Comptroller of the Currency OCC), Federal Reserve, and Federal Deposit Insurance Corporation (FDIC) report on servicing is currently underway as the joint agency response to the foreclosure and MERS scandals. The report is expected in the coming weeks.
- Another area where financial regulators are set to issue a proposal is on the topic of what constitutes a Qualified Residential Mortgage (QRM). This definition will be defined by a joint-rulemaking and will become the standard classification relating to the risk-retention standards for mortgage originators. It is expected that any QRM standard will include a requirement of a down payment of 20% along with a sufficiently high credit score. If a mortgage met this standard, it would mean that originators and securitizers would no longer need to maintain 5% “skin in the game.”
- The Treasury’s mortgage modification programs, funded by TARP, also continue to be examined by Congress and the Special Inspector General for TARP, Neil Barofsky. On Wednesday, the House Committee on Oversight and Government Reform, chaired by Darrell Issa (R-CA), held its first hearing, which concerned TARP and the Obama Administration’s mortgage modification programs, including the Home Affordable Modification Program (HAMP) as well as Administration actions (or lack thereof) against mortgage servicers.
- As expected, the hearing was mostly political theater, with Chairman Issa infuriating Committee Ranking Member Elijah Cummings (D-MD) by refusing to allow any opening statements or the Ranking Member’s requested witness from JPMorgan Chase Mortgage Servicing. Barofsky was the main witness, while Tim Massad, Acting Assistant Secretary for Financial Stability, testified on behalf of Treasury Secretary Geithner.
- As usual, Barofsky presented HAMP as a failure, since it has failed to assist the millions it was created to target, while Massad defended the program as a success, despite falling short of its lofty goals. Additionally, Massad stated that mortgage servicers involved in the program had altered their behavior in ways which were benefiting homeowners.
- Look for Congressional Republicans to discuss termination of the HAMP program, but it is unlikely that Republicans will pursue this idea with legislation, especially considering all of the problems with mortgage servicing, the continued foreclosure epidemic, and their attempts to develop a reform strategy for the GSEs.
- Democrats will continue to hammer on mortgage servicers and the lack of investigation and sanctions by the Obama Administration on servicers. Barofsky has also assured the Oversight Committee that criminal investigations and audits of the largest servicers are currently underway, in addition to the 50 state attorneys’ general investigation, though he also emphasized that the Administration could and should do more in this area.
- Also on the topic of mortgage servicing, House Financial Services Oversight Subcommittee Chair Randy Neugebauer (R-TX) spoke to an NYU-UMD conference on the future of the GSEs this week. During his remarks he called for an end to the government’s attempts to mitigate foreclosures, including HAMP, because of how these programs prolonged the overhang of housing inventory and distorted market discipline.
- Rep. Neugebauer: “There is pain to be had out there in this marketplace…unfortunately some of those individuals should not have bought houses in the first place…The sooner we can get that inventory into the economy, the sooner I believe that housing prices will begin to stabilize.”
- Neugebauer has also written to FHFA Acting Director Ed DeMarco this past December (see attached letter) concerning discussions that the Obama Administration was considering implementing a streamlined process for moving homeowners whose mortgages are owned by Fannie and Freddie into renegotiated FHA loans and the implications this would have for both taxpayers and moral hazard.
- A second letter on this topic, as well as on mortgage servicing, is currently being drafted by Neugebauer. Expect that hearings on this topic will occur in the future, after an initial hearing on taxpayer funding of legal expenses for former executives.
GSE Reform Efforts in Congress
- After the release of the White House report on options for the future of housing finance, look for Congress, especially Republicans in the House of Representatives, to take the lead in proposing GSE reforms.
- The House Financial Services Committee has already scheduled four hearings on housing and GSE-related topics (see attached list). When following these developments, it is important to note that the Committee’s rules have reverted to “regular order” whereby the Subcommittee Chairs will hold all, or nearly all, of the hearings on individual topics and investigations, leaving the full Committee hearings, led by Chairman Spencer Bachus (R-AL), for marking up legislation and receiving prominent figures, such as Federal Reserve Chairman Bernanke.
- This significant change will introduce new names and characters into the contentious world of housing finance, including the aforementioned Rep. Neugebauer (R-TX); Rep. Jeb Hensarling (R-TX), Committee Vice-Chair; Rep. Scott Garrett (R-NJ), Chairman of the Subcommittee on Capital Markets & GSEs; Rep. Judy Biggert (R-IL), Chairman of the Subcommittee on Insurance, Housing and Community Opportunity; and Rep. Shelley Moore Capito (R-WV), Chairman of the Subcommittee on Financial Institutions and Consumer Credit.
- The list of hearings shows that housing finance and GSE reform are the main focus of the Committee, save Dodd-Frank oversight and macroeconomic policy. What has also become apparent is that Committee Republicans are no further along in devising a credible plan for reform of the GSEs than they were during Dodd-Frank Act negotiations. After conversations with House staff, it is likely that Vice-Chairman Hensarling’s bill from the 11th Congress (attached to this update) remains the starting point for Republican legislative reforms. The bill was widely derided in the 111th Congress as “unserious,” since it remains ideologically pure, and refuses to acknowledge the fact that the GSEs currently represent nearly 100% of the mortgage securitization market, alongside an extremely weak housing market. With this in mind, look for the Obama Administration, despite their internal disagreements, to acknowledge this reality and allow Republicans to take the lead in this contentious area as part of a delaying tactic, hoping to push reform off for as long as possible.
- As mentioned earlier, House Republicans have painted themselves into a corner, consistently and eagerly proclaiming that any government guarantee or involvement in the housing finance markets, save perhaps the Federal Housing Administration and Veterans Administration (for providing assistance to first-time moderate income homebuyers), is unacceptable. Look for any House Republican bill to draw heavily from the work of Peter Wallison, who along with Alex Pollock and Edward Pinto, have recently released a White Paper entitled: “Taking the Government Out of Housing Finance: Principles for Reforming the Housing Finance Market.” (Attached to this update)
- Rep. Garrett, who is expected to lead the way on this issue, has been quoted this past week saying definitively, “There can’t be any explicit guarantee. The main problem has been that the taxpayer has been on the hook for this credit risk for a long time. We are adamant there should be no more bailouts.” This will make any compromise with the Democrat-controlled Senate very difficult, if not impossible, let alone with the Obama Administration.
- Although Garrett and his fellow House Republicans are often portrayed as sympathetic to the financial services industry, the Congressman has also been quick to pour his scorn on an industry proposal, from the Financial Services Roundtable (attached to this update), which proposes to replace the GSEs with several privately capitalized firms that would package mortgage-backed securities, while the federal government would guarantee the interest and principal for investors. In theory the very same entities securitizing nonconforming and private label securities would also be the co-owners of the guaranteeing entities, but these would only be allowed to work with traditional, conforming, 30 year mortgages. The Federal guarantee would not apply to the new entity itself, or any debts or securities issued by them to cover the costs of their operation.
- The problem for Garrett and other Republicans will be the presence of a “federal catastrophic insurance fund,” similar to that which was put in place after 9/11 for terrorism reinsurance. This fund would support the guarantee only if one of these firms fell into financial trouble. The guarantee firms would contribute to the insurance fund and several layers of capital would need to be used up before the government was responsible. Even this level of taxpayer exposure is unacceptable to many Republicans.
- Instead of any government support, the Republican school of thought espouses a housing finance sector where the government operates only on the margins, by setting and enforcing standards for what types of mortgages can be securitized, what are appropriate servicing standards and procedures, and potentially by explicitly offering rental assistance for affordable housing. Most plans for privatization of the GSEs are implemented chiefly through the gradual reduction in the size of the conforming loan limit (at a rate of around 20% per year), so that in theory, the private sector is able to securitize more and more newly originated mortgages, and/or an alternative such as covered bonds are introduced.
- Due to the problems that may result from such a plan, it is likely that the Senate Banking Committee will proceed on GSE reform at a far more deliberate pace than the House akin to the recent Dodd-Frank Act preparations. The Senate Committee (which has yet to hold its first organizational hearing) also will have several new personalities, including a new Chairman, Tim Johnson (D-SD). Its increased Republican presence, which is increasingly made up of conservative-leaning members, will likely echo the House Republicans. Two Senate Republicans are likely to emerge as key thought-leaders in this debate, Senator Mike Crapo (R-ID) and Bob Corker (R-TN). Early indications are that although they each consistently show concern for taxpayers, they both recognize the inherent risks of rushing though a privatization of the GSEs with a weak housing market and without deep and serious reforms of the other aspects of housing finance, such as the rules regarding securitization (including servicing standards, representations and warranties, MERS, etc.)
- It is doubtful that any substantive legislation will be introduced before the summer and even then, it will likely only be in the House, with the Senate months, if not nearly a year behind.