GSEs (Fannie/Freddie),FHA&HUD

Thoughts on Fixing FNMA and Freddie

Posted on Thursday, August 19, 2010

Before we can decide what to do with FNMA and FREDDIE we need to decide what government’s role in 21st century housing should be. What exactly do we think American’s are entitled to when it comes to housing? Is there an obligation on the part of our society to provide every American with a decent place to live (as in a nice rental meets with requirement) ? Or do we owe everyone actual legal ownership of the home they live in? The answer to that question will in large part determine how the public purpose side of the GSE equation is solved.
Regardless, most experts agree that a fundamental element of any solution is going to be separating the private profit-driven piece of the GSEs from their public policy mandate of supporting low and mid-income affordable housing. The conflicts inherent in those two positions have been talked-about to death. They just can’t co-exist in a way that does justice to both.
At least with regard to the private profit-driven piece, and any other area in which we hope to encourage private industry competition, the special advantages afforded to the GSEs – lower capital reserve requirements (FREDDIE held only $900 for every $200,000.00 in mortgage debt!), lower rates, political clout (who else could get away with the accounting improprieties, insider loans and the like?), and of course that now infamous ‘implied government guarantee,’ will have to be eliminated in order to create a level playing field. Ironically, the GSEs, created to enhance stability, affordability and liquidity, are now actually inhibiting these very things by keeping private competition out of the market simply due to their inability to effectively compete with enterprises given such special treatment.
There is no doubt that the GSEs will continue to play some role in the future of US housing. Given that the country faces some sort of credit crunch that impacts housing every decade, and certainly in the event of a future emergency as we have seen over the past few years, government needs a tool like to GSEs. Housing is a large part of our overall economy and a super politicized part at that. But hopefully the GSE role of the future will be a fraction of what it has been. perhaps as a bank or securitizer or guarantor of last resort. And of course, to protect the tax payers, any actually government backing the ends up in the final picture will have to be explicit and included in every relevant government budget and balance sheet.
Any plan for the GSEs will need to address the short term need for (a) deleveraging and (b) containing as much damage as possible, as well as (c) what to do with those toxic assets, and (d) long term, preventing similar problems from occurring in the future. So far much of the ‘future’ related reform being suggested centers around how to best insure that the borrowers underlying the loans underlying the GSEs do not default and insure that the MBS issued based on those loans do not subject the GSEs (and taxpayers) to inordinate risk. At balance is that key question of what elements of housing are Americans entitled to from their government and at what risk or cost to the taxpayer? Which begs the question, if leaders believe there’s no one in the private industry who will be able to figure out a way to not lose money on certain home mortgages for low and mid income housing (presumably the riskier loans for riskier borrowers), why should our government take that risk? In other words, what’s the problem with making sure those folks have a safe rental to live in until they can get their act together and afford a loan investors do not consider high risk? Isn’t that the behavior we want to reward? Isnt that the American Dream?
Republicans on the House Financial services Committee are calling for a 4 year wind down complete with 25% annual portfolio reduction, phased in capital requirements and reduction of loan approval limits. Other ideas include; An explicit Federal guarantee on MBS along with a tax on MBS to fund low income housing and required housing mandates for MBS issuers. Other suggest the opposite, removing the housing mandate altogether to encourage private competition. Or underwriting improvements including increased down payments, loan limits, a return to more traditional apprisal requirements. Some tweak this by phasing in an additional 1% down each year for the next 15 years until we return to more traditional 20% down requirements. Ditto the loan limits which some suggest should be decreased by 1% a year until they reach the same level as FHA and then can be taken over by that agency. Increasing transparency by requiring all costs to appear on all relevant government budgets seems to have no objectors. The Center for American Progress has suggested creating several government chartered MBS issuers (called CMI) to sell securities guaranteed by the government. The Fed would determine eligible loans. And the entity would be privately owned, with profits regulated by government. A fee per deal would cover the risk assumed by the government. another suggestion is to create three entities, one private to package MBS for Wall Street, one government to promote the public policy goals, and the other to simply liquidate exsiting GSE bad assets. My favorite is a tx credit for homeowners who pay down their mortgage, paid for by forgoing the mortgage interest tax write off. Remember, FNMA also serves as one of the country’s largest multi family lenders so any plan will need to address that piece as well.
Some folks are citing unwinding the GSEs as a major issue. No doubt it will be a challenge. Timing and addressing the overall lack of confidence and uncertainty are key. Together with FHA the GSEs have a finger in 90% of the residential mortgages now. They service 50%. And FNMA is the primary administrator for President Obama’s Making Home Affordable program, as well as the model for standardizing many pieces of the mortgage business, including auto-mated underwriting. FNMA plays a central role in financing 40% of the multi-family housing in our country. An estimated $1.3 trillion investment in or backed by GSEs is held by our foreign friends. The impact on the derivatives market will also be felt. Placing the GSEs into conservatorship amounted to a bankruptcy under many contracts. And of course their losses are still growing. Any mid crisis restructuring is challenging. But that does not mean it can’t be done. Sallie Mae (a smaller less complicated GSE no doubt) was successfully restructured using a holding company with a GSE and a non GSE subsidiary in 1996. The FDIC is successfully ‘restructuring’ hundreds of banks using loss share agreements. And we all watched as Bear Sterns, Lehman, and others were ‘restructured’ overnight.
Certainly restructuring the GSEs is doable. In fact, it’s already been done before. FNMA was chartered in 1938, but the Charter Act of 1954 provided the framework under which FNMA operates today. It removed government backing for borrowings used to fund secondary market operations, granted exemption from local taxes, and laid the path for converting FNMAs secondary market operations to the private sector (proceeds from the sale of private stock retired Treasury owned preferred stock). The 1968 Charter Act split FNMA into two parts; GNMA and a new government sponsored private corporation version of the former FNMA with authority to issue MBS. The Emergency Home Finance Act of 1970, Secondary Mortgage Market Enhancement Act of 1984, Financial Institutions Reform, Recovery and Enforcement Act of 1989, Federal Housing Enterprises Financial Safety and Soundness Act of 1992, and most recently, The Housing and Economic Recovery Act of 2008 complete the GSEs historical picture.
It’s no surprise that the GSE were not addressed in the Dodd Frank Act (although requirements that MBS issuers retain 5% risk excluding FHA will have an impact). The GSEs were put into conservatorship in September 2009. On Christmas Eve they were written a blank check until 2012. And their losses are not being reported in our nation’s budget or on the balance sheet. with all the control and limited transparency there is no incentive for the Administration to discuss change now. Dodd Frank is more of a ‘thou shalt not’ act, peppered with words like ‘oversight’ ‘authority’ ‘powers’ ‘transparency’ ‘accountability’ ‘protections’ ‘improvements’ and ‘reforms.’ And its scope is much larger than the GSEs and housing, touching hedge funds, insurance, swap markets, securities, financial institutions, and predatory lending.
At the end of the day it seems we will wind up with a more private looking version of the GSE, still empowered to provide the tools needed in a crisis. And the American dream as a rental home is likely to be a piece of the final picture given that the GSEs are well on their way (like the HOLC after the Great Depression) to becoming the country’s biggest landlord. Already FNMA’s lease for deed is heading in that direction. While I happen to agree that governments role should be to assure housing, not homeownership, this does raise a concern for our future retires since the average pre-bubble homeowner had a net personal worth (including home equity) of $88,000 in comparison to a renters $4,000. But funding homeownership for folks who cannot ultimately sustain their loans is certainly not the answer to that equation.

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