(Archived Content)
After more than five years in conservatorship, there is broad agreement among policymakers on both sides of the aisle that these companies and their flawed business models —which failed the American people at the moment when they were needed most—must be wound down. Going forward, the conversation now turns to more a nuanced policy debate around the most effective structure of a post-GSE world. A key will be how to leverage the valuable assets of the legacy system in designing a safer, more competitive and accessible mortgage market while helping to ensure that taxpayers are protected from future losses.
Building upon this strong foundation, here is a list of six important “stakes in the ground,” included in the proposed Committee bill that mark the evolving consensus around the contours of a future housing finance system. The Johnson-Crapo bill thus provides the momentum and the basis going forward for all serious deliberations necessary to achieve fundamental housing finance reform:
1. Explicit government guarantee – An explicit [and paid for] government guarantee on mortgage-backed securities is necessary to attract sufficient funding to meet the mortgage needs of American families at scale and at the lowest possible costs. The mortgage funding needs in our country vastly exceed what bank deposits would be able to provide and what investors would be willing to take on when both prepayment and credit risk is combined. The catastrophic government guarantee separates credit risk from prepayment and interest rate risk, preserving the role for what we call “rate investors;” those domestic and international investors willing and able to take on interest rate risk but not credit risk. It is these rate investors that are able to provide sufficient amounts of funding at the most efficient prices on long term fixed rate mortgages. The guarantee also preserves the deep and liquid TBA market, which allows borrowers to lock in their rates ahead of closing. This efficiently allocates the risks of long-term fixed-rate mortgage products among investors most suited to take on that risk, maintaining the wide availability of the 30 year fixed rate mortgage.
2. Greater role for private capital to take mortgage credit risk – The Administration, a wide range of stakeholders, and legislators on both sides of the aisle agree that extending mortgage credit and absorbing the first loss risk is a role that private capital can and should play for the majority of loans originated in our country. Consequently, the Committee’s bill requires significant private capital to take the first loss and stipulates that private capital be completely wiped out before the government catastrophic guarantee kicks in.
3. Reduced concentration of credit risk - The perils of concentrating mortgage credit risk in two companies that also controlled the pipes for the nation’s securitization system, were borne out in the financial crisis, as the size and importance of the GSE duopoly threatened to destabilize the financial system, requiring unprecedented taxpayer support. In a reformed system, private companies and investors that absorb credit risk should be separate from the securitization infrastructure, allowing them to fail and be wound down in an orderly fashion without taking the entire mortgage backed security system down with them. S. 1217 balances the need to distribute both the risk exposure and functionality of the future housing finance system among actors.
4. Countercyclical role - Home prices would have fallen much further and the economy would have suffered to a much greater extent in the recent crisis without government intervention. In order for any future mortgage finance system to work in all economic times, it must maintain cyclical resilience. This means that mortgages are available to qualified borrowers during a severe economic downturn or financial disruption. To achieve this, the bill establishes a clear and institutionalized structure for the government to expand its credit-risk remote role temporarily and flexibly.
5. Affordable housing options – It goes without saying that the benefits of a government guarantee on MBS should be available to all creditworthy borrowers. The bill also provides for an explicit and transparent revenue stream by applying a fee on these government backed MBS to support housing for low-income families the private market cannot serve without subsidy.
6. Using GSE infrastructure and assets in future system – Finally, the bill acknowledges that despite critical deficiencies in the GSE business model that requires comprehensive reform there are many aspects of the current system that can be preserved to help provide a solid foundation on which to build the future system. The measure allows for the sale and repurposing of critical GSE assets—systems, infrastructure, and human capital, which not only helps to preserve what works, but also supports a smooth transition.
To summarize, the case for getting on with housing finance reform centers on the undeniable fact that at its very core, the GSE business model—through bad times and good—continues to depend upon the support of the American taxpayer.
And for those who think that the GSEs’ structural problems are a thing of the past, inaugural GSE stress test results recently published by the Federal Housing Finance Agency pursuant to requirements of the Dodd-Frank Act reveals the folly of those beliefs. Under an economic stress scenario similar to the most recent crisis, GSE forecasted credit losses would be so great that an additional $190 billion would have to be drawn from the Treasury to support these companies over a two-year period. This is an amount slightly greater than the total amount the American taxpayers have invested in these companies from the beginning of their conservatorship. Absent reform, we could, quite literally, end up with history repeating itself.
Whatever the outcome of tomorrow’s vote, we will keep working to improve the bill and broaden support for full senate consideration in an effort to complete the last piece of unfinished business of financial reform.
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