GSEs (Fannie/Freddie),FHA&HUD


Posted on Friday, April 9, 2010

Of course they can! The problems have been known for years. Way back in the 1980s – before many of us could even vote - HUD studied the notion of privatizing the FNMA and Freddie. In 1986 a Freddie Advisor Committee concluded in order to privatize the GSE they would also need to do the same with FNMA. In the 1990s HUD published papers on the subject. In 1991 the CBO did its own report. In 1992 Congress requested more studies. In 2003 Bush tried replacing the Office Federal Housing Enterprise Oversight – created after the S&L crisis in 1992. And in 2005 the Federal Housing Enterprise Regulatory Reform Act was kicked around before dying on the vine.
But thing are different now. Now that an actual crisis has proven all the theoretical concerns true, anyone who questions or ignored the warning is dodging to hide from the blame being tossed around aplenty. I doubt there’s anyone left who will dispute that the public purpose, special treatment, money at risk, conflicts with the private profit incentives - fighting capital reserve requirements. In fact, the benefits of special treatment saved the GSE’s $2 billion in borrowing costs compared to private entities last year. Likewise, no one will dispute that the implicit guarantee of government backing is a problem as is the fact that the GSEs have become far too large, are rampant with systemic risk and in fact define the notion of “too big to fail.” The conflict between on and off balance sheet budgets and recent corruption allegations is enough to push anyone still on the fence over the edge. But perhaps equally important is the fact that the GSEs worked in achieving what they were intended to do - improve market efficiencies. So even though their charters contain no sunset clause (one might wonder why), the time has come to put them to rest. They (along with other factors) have provided liquidity to credit markets on national (as opposed to regional or state) basis. They have decreased the cost of home mortgages by ¼ point, enabling 400,00 more homeowners a year. And increased mortgage liquidity. But the GSEs are next in line for reform, much in the tradition of former mercantile financial institutions.
Much like training wheels on a bicycle, the process of removing the GSEs may be scary and need to be done in steps, but the GSEs are no longer needed in their original capacity and in fact are doing more harm to private enterprise than good. Things have changed. We now have international markets, securitization systems in place, access to borrower default risk information, borrowers can reach lenders, interstate banking barriers are all but gone, all allowing capital to flow between regions and sectors.
Likewise, the American Dream itself has also evolved. It used to be all about working hard for stuff and security. Government loans turned this into something else. The time has come to re-balance cultural components with economic incentives and consumer spending which may eventually lead us to re-examine some of the other many government programs subsidize housing. Are they in place to support he American Dream or our GDP and consumption, 75% of which comes from main street (over) spending.
No doubt this will lead to a great deal of philosophical dialogue over the next few years; How involved should government be? Government role and goals. How much risk? Is government advantage fair? Is intervention fair? Do we still need GSE to improve efficiency. Are they doing that? Does housing finance system dampen or worsen boom-bust cycles? Is Federal presence necessary in some markets? I have no doubt many will claim their ideas are the one consistent with the American Dream.
Reaching consensu on the goals, structure, methods to get there will certainly be a challenge. Constraints include the GSE size and complexity, loose regulations, politics favor status quo, the need to maintain stability, not cost tax payers, address existing investors, and perhaps the biggest obstacle, the power of existing management and infrastructure and upfront costs.
Many are already expressing positions. Geithner’s made is clear there will be no change until 2011. He wants to put distance between crisis and new model. In fact during the recent March 23 House Financial Services Committee hearing, in the course of 2.5 hours of testimony and Q&A most of what we got was philosophical. There was also lots of discussion on who to blame for allowing, even forcing, the GSEs to get so big. From what we can see, government plans to collect information this year and wait for housing to recover. But there does seem to be agreement that we need to avoid private gain at public risk and loss and define a clear role for the GSEs moving forward. Bernanke has called the GSE’s “no mans land.” In January 2009 Paulson noted the market needs more private involvement and acknowledged the “inherent conflict, adding the GSEs should be Portfolioing only what’s necessary. So far the conservatorship, blank check on Christmas Eve and refusal to address the GSE’s in the budget have not been terribly comforting.
Key members of the U.S. House Committee on Financial Services; sub-committee Capital Markets, Insurance and GSEs have also chimed in. Republicans minority leading Spencer Bachus has been advocating the Republic plan which essentially involves privatization, a 2 to 4 year wind down, loan limits, portfolio limits, leverage limits/increase reserve requirements, more regulation and inclusion on the Federal budget. The plan outlines 5 goals and 10 principals. Congressman Bachus has said the current GSEs are not an American model. Proposed H.R. 3310 Consumer Protection and Regulatory Enhancement Act provide further insight into what folks are thinking in Washington. Committee chair Frank has admonished “I told you so” adding that the current hybrid model is a mistake and not working. Congressman Kanjorski says his main concern is that the GSEs are too large and interconnected with systemic risk, adding he thinks there are 5 or 6 alternatives and favors making 10 to 12 mini entities. But he seems to feel the need is to “get ship back on course, not redirect it altogether.” And of course he blames Wall Street. Of course a plethora of lobbying by interested groups is expected. The National Association of Realtors is already advocating converting the existing two GSEs into government charter not for profits. Because of existing infrastructure and prominence in Mortgage Securities. Government clearly guarantee and mitigate taxpayer risk with mortgage insurance and guarantee fees. Also pending: FNMA and Freddie Accountability and Transparency for Taxpayers Act (FFTTA Act) mostly addresses reporting requirements.
H.R. 3310 Consumer Protection and Regulatory Enhancement Act
Private capital should be primary source for housing.
4 year wind down.
2 year elevated loan limit in high cost areas (“millionaire mortgage”) phase out
4 year mortgage portfolio holding reduction @ 25% per year
4 year capital requirement phase in to reduce leverage
Bridge gap between long term commitment and short term borrowing
Create IG for FHFA to submit regular reports to Congress for conservatorship
Moe liabilities onto federal budget/subject to national debt limit
Suspend executive compensation packages.

The reality is the crisis is still in play. GSE’s are playing a central role. Private capital is not back yet. The short term priority is navigating the crisis. Keep mortgage money available and rates low to stabilize housing. Keep the MBS market stable; $1,318 trillion in GSEs are held by foreign investors who need to be kept happy. Derivative counter-parties would be overwhelmed by defaults. 50% of all mortgages are serviced by the GSEs. With FHA, 90% of new loan originations are done by them. And here’s the real Catch 22: HERA of 2008 requires receivership if FHFA Director determines GSE has net worth deficit 60 days after end of fiscal quarter. FHFA required to request additional Treasury funds under Preferred Stock Purchase Agreement to avoid mandatory receivership. Dividends GSEs pay or accrue to Treasury investment (especially as amount funded increases) adversely affects their net worth, leading to need for more funds to maintain net worth and avoid receivership. Dividend obligations plus inability to pay draw downs under Preferred Stock Purchase Agreement due to net worth deficit concerns, will insure government dependency.
Possible models include Nationalization (Less than optimal-no private credit risk evaluation or innovation), Partial Guarantee (for MBS creates floor on MBS losses for investors but requires them to evaluate risk. Problematic), Privatization (remove all government support and break up size), Housing Utility (could be best way to resolve inherent conflict. Purchase and securitize mortgages with credit guarantee backed y government. No investment portfolio. Privately owned but rate setting commission also approves products and underwriting innovations). And we can look to the Sallie Mae privatization; Began 1996 SLMA Reorganization Act (Republican). Ended 4 years early in 2004 (but only established 1972 and much smaller dollars, web,etc. Didn’t set markets, etc). Refinanced $100 billion assets with securitized and unsecured holding company debt. Enabled diversification. Succeeded in mission. “Life Cycle of a GSE.” Managed over $98 billion student loans for 7 million borrowers. Biggest originator of Federally insured student loans. Research; 2005 Warton paper, American Enterprise Institute for Public Policy Research. Also in 1991 the small GSE National Consumer Cooperative Bank was privatized. With Roosevelt’s New Deal 1933 Homeowners Refinancing Act lead to Home Owners Loan Corporation HOLC. Extended short term loans to 20 or 25 years. Assisted lender by refinancing problem loans/increased liquidity. Assisted millions of people. Stopped lending in 1935 (ran out of money). Non farm homes under $25k. Closed 1951. Turned small profit. There’s no shortage of examples, research, and ideas for winding down government programs and entities.
In its recent report, Helping Housing Recover: A Report on Fannie Mae’s Mission Performance, it was noted; $823.6 billion to help keep the single-family and multifamily mortgage markets operating during 2009. More than 40 percent of the mortgage-related securities issuances. More than 40 percent of financing for rental housing. Mortgage funding for 3.1 million borrowers. Helped 2.5 million borrowers refinance. 600,000 borrowers buy Aided in the purchase, refinance, or rehabilitation of 372,000 rental units. More than 160,000 borrowers with Fannie Mae-owned loans were able to keep their homes through a loan modification or other loan assistance.

Some of the other figures?
US Taxpayers own 80%.
2009 FNMA $72 billion loss. $58 billion 2008. FRED $21.6 billion losses. Net worth $4.4 billion.
Total losses since 2008 take over as of Feb 2010; FNMA $111 billion. FRED $70 billion. FNMA taken $60 billion from Treasury credit line. FRED $51 billion.
CBO and OMB (oversees President’s budget) calculate GSE cost to taxpayers differently. 2010 taxpayer cost CBO $21 billion/OMB $69 billion.
FNMA Leverage as of September 2008 20;1. Freddie 70.1 (average investment bank 30:1).
Combined size of FNMA and Freddie has doubled every 5 years since 1968.
Now hold or pool $5 trillion in mortgages.

1916 first GSE Farm Credit System
1932 Federal Home Loan Banks (first move into housing)
1937 HUD US Housing Act of 1937
1938 Roosevelt’s New Deal. National Housing Act. FNMA established as Federal agency.
1968 GNMA chartered by Congress as private shareholder-owned company. Johnson.
1970 FRED
1972 Sallie Mae privatized
1992 wake of S&L Office of Federal Housing Enterprise Oversight created as part of HUD. 2003 Bush tried to create new agency replacing Office of Federal Housing Enterprise Oversight to oversee FNMA and FRED. 2005 Federal Housing Enterprise Regulatory Reform Act would have increased government oversight of FNMA and FRED loans. Capitalization and risk questioned for some time. Regulators didn’t have authority to address. Reform frozen. Crony capitalism. Corruption. 2007 55% had to be low income/minority.
March 2007 House Financial Services Committee passed Federal Housing Reform Act 2007. Established FHFA. Preferred Stock Purchase Agreement.
2008 investors lost confidence. Stock plummeted. Government had to move fast. Sept 2008 FHFA Director Lockhart appointed FHFA as conservator. US Treasury Department agreed to provide up to $200 billion (with FRED). Devised Preferred Stock Purchase Agreements /back stop losses per authority granted in HERA of 2008. HERA of 2008 combined OFHEO and FHFB into new FHFA
Feb 2009 raised Senior Preferred commitment to $400 billion.
Dec 31, 2009 removed limits through 2012.

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