(Archived Content)
As prepared for delivery
ORLANDO, FLORIDA - Thanks very much to the National Federation of Municipal Analysts for including a housing finance panel in this year’s conference and for giving me the opportunity to speak about the Administration’s important work to reform the nation’s housing finance system.
As you’ve heard from my fellow panelists, the housing market has substantially rebounded from the depths of the crisis amidst the broader economic recovery. Home prices are rising on a national level. This has dramatically reduced the number of homeowners that owe more than their homes are worth. Rates of mortgage delinquency and foreclosure have declined significantly. And housing starts, new home sales, and existing home sales all reached multi-year highs last year. Additionally, the improving labor market and broader economic conditions can help strengthen the housing market further.
We recognize that many of these indicators are still well below pre-bubble levels, the recovery has been uneven across geographies, and the most recent data has been softer than the last year.
However, given the relative stability of the housing recovery, we believe that now is the time to reform the system and begin the long transition to a safer and more sustainable housing marketplace instead of waiting until the next crisis to address this complex issue.
Critical flaws in the legacy system cannot be fixed without legislation, in order to provide a lasting, sustainable housing finance system that is better for borrowers and better for taxpayers.
The legacy system lacked sufficient regulatory oversight and resulted in misaligned incentives that led to deterioration in underwriting standards in an effort to regain lost market share. The GSEs’ failed business model allowed private shareholders to reap unlimited profits, but left taxpayers shouldering enormous losses. And the secondary market infrastructure – including the securitization pipes – upon which the mortgage finance system depended, were owned by Fannie and Freddie, the same entities that held the credit risk they were unable to bear. As a result, taxpayers had to step in and provide substantial capital support so that mortgage credit could continue to flow and to prevent the recession from getting worse.
In order to fix these fundamental flaws, the President has committed to four principles for a future system:
1. Put Private Capital at the Center of the Housing Finance System. A reformed system must have a limited government role, encourage a return of private capital, and put the risk and rewards associated with mortgage lending in the hands of private actors, not the taxpayers.
2. End Fannie Mae and Freddie Mac’s Failed Business Model So Taxpayers Are Never Again on the Hook for Bad Loans and Bailouts. Private capital should bear the substantial majority of losses and must be wiped out before the government pays out on catastrophic guarantees on MBS. And the government should collect explicit and actuarially-fair premiums for the catastrophic guarantee it provides.
3. Ensure Widespread Access to Safe and Responsible Mortgages like the 30-year Fixed Rate Mortgage in Good and Bad Economic Times.
4. Support Affordability and Access to Homeownership for Creditworthy First-Time Buyers and Access to Affordable Rental Housing for Middle Class Families and Those Aspiring to Be.
More than five and a half years after the GSEs were put into conservatorship, we still face a housing finance system that is only partially working. Taxpayers continue to be exposed to future losses; there is a lack of adequate mortgage credit availability; and there is a lack of private capital taking credit risk. The underlying housing finance system is merely a patchwork of what was intended to be temporary fixes during the crisis.
Putting in place a permanent, durable housing finance system is more important than ever to municipal housing issuers, who, in the absence of a well-functioning tax-exempt mortgage revenue bond market, have been forced to rely almost exclusively on government channels. Housing finance agencies have been valuable partners in the Administration’s mission to ensure access by first-time homebuyers and other underserved populations to affordable mortgage products, which makes it more important than ever to clear up the uncertainty around the future role of the government in housing finance so they can continue their important mission. While tax-exempt executions may again become attractive, the importance of ensuring that HFAs have multiple financing options including a reliable government channel cannot be overstated.
Now, some continue to believe the current system with the GSEs in conservatorship is sustainable or that with a few tweaks, it can be fixed without legislation. We could not disagree more. Supporters of the status quo seem to ignore the lingering risks to taxpayers of keeping the GSEs in conservatorship should there be another significant downturn in the housing market.
And those who argue for fixing Fannie and Freddie, a reform-lite approach, ignore the fact that legislation is needed to make even small changes to the GSEs’ charters to fix their failed business models. As we see it, a legislative tweak here, and another there, and as all the necessary tweaks add up, before you know it we’re looking at comprehensive housing finance reform.
For example, there is broad consensus that, in the reformed system, the implicit federal guarantee must be replaced with an explicit federal guarantee; but the guarantee should apply only to mortgage-backed securities and not to the firms that issue them. However, this legislative tweak is insufficient on its own.
It also requires a strong regulatory regime to govern the scope and application of the guarantee; provide requirements for private first loss capital, and create an insurance fund to protect taxpayers. These fixes also require Congressional action. And preserving a deep and liquid TBA market lends itself to the creation of a single security and accordingly, a single securitizer.
Critical securitization and issuance infrastructure should be separate from and not be owned or controlled by the firms that take the mortgage credit risk. This would not only help lower barriers to entry for originators and those who want to take credit risk, but it would allow firms to fail without bringing down the entire securitization system. And, of course, these fixes, too, require legislation.
When the time comes to stop the GSEs from doing new business, we would not want their legacy MBS to become orphan securities. Legislation would be required to apply the same full faith and credit federal guarantee on Fannie and Freddie securities as would be applied to the new securities. And finally, because the government would still be putting itself at risk in the new system, we need to address the issue of fairness.
There needs to be some certainty that the benefits of the government guarantee in a reformed system will be available broadly to lenders in all geographies and to creditworthy borrowers of all backgrounds and characteristics. And finally, to make sure that there are ample affordable options for those who choose to rent, we need to bring similar reforms to the multifamily housing finance market; which again requires legislation.
And so, we come full circle: because each of these elements is intertwined, they must be considered as part of a comprehensive package; which essentially means that a reform-lite approach to housing finance reform is simply not an option. Some advocates of maintaining the status quo also point to the widely reported GSE record earnings over the past year as evidence that the Administration is over-stating the urgency of pursuing housing finance reform.
While this good news reflects positive trends in the housing market, Fannie and Freddie’s outsized recent performance may significantly overstate the true financial condition of these two deeply subsidized companies; especially on a go-forward basis. One-time tax reversals, settlements of legacy MBS litigation, and releases of loan loss reserves compose the significant share of these recent gains.
While the role of these one-time gains on the GSEs’ recent financial reports are increasingly noted by market participants, less attention is paid to the extraordinary value of Treasury’s continued capital support which allows the GSEs to borrow at very low cost, more akin to sovereign rates than those of a private company issuing corporate debt.
This allows the GSEs to earn a much more substantial spread on their portfolio than they could as private firms. In 2013, excluding one-time gains, more than 55 percent of Fannie and Freddie’s combined earnings were generated through their retained portfolios, which are required to shrink by 15 percent per year on a go-forward basis under Treasury’s Preferred Stock Purchase Agreements.
Even Freddie Mac’s CEO recently publicly recognized the outsized importance of these factors, acknowledging that “[O]ur core earnings are a mere fraction of what has recently been reported...." But it’s not just that the profits from their retained portfolios are enlarged because of their taxpayer-backed lower borrowing costs -- the same can be said for their highly profitable bread and butter, post-2009 core mortgage guaranty business. Without Treasury supporting up to $241 billion in potential future GSE credit losses, the value to investors of Fannie Mae and Freddie Mac’s guaranty of timely payment of principal and interest on their respective MBS would be greatly diminished.
And so, 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, last week’s inaugural stress test results 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.
The message here is that the longer we put these reforms off, the easier it is to forget the damage to the economy, loss of housing wealth, and instability that a system with misaligned incentives and inadequate taxpayer and consumer protections can bring.
Last summer, with S.1217, Senators Bob Corker and Mark Warner introduced the first bipartisan housing finance reform legislation in Congress. Over the last several months, the Administration has worked closely with the Senate Banking Committee, culminating with the release of a discussion draft by Committee Chairman Tim Johnson and Ranking Member Mike Crapo.
The draft legislation would establish an explicit government guarantee on mortgage backed securities that the government would charge for, and would require significant private capital in the first loss position ahead of that guarantee. It would establish a new housing regulator, providing strong protections for taxpayers and oversight of entities participating in the new market. It also would include an affordability fee which would generate a stream of revenue to support low and middle-income rental and ownership, which the private market cannot serve without subsidy. It also would establish a similar framework for multifamily housing – because we recognize that ownership is not right for everyone - to support affordable rental options.
Johnson-Crapo entered the mark-up process a week ago Tuesday, and we expect this important work to continue in the coming days, as the leadership continues their efforts to attract additional support for the bill. We look forward to the mark-up and Committee vote, which will be an important milestone in our commitment to build a more sustainable mortgage finance system that will better serve the American people.
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