Seven years after the mortgage crisis, and the placing of Fannie Mae and Freddie Mac into conservatorship under the independent federal agency, the Federal Housing Finance Agency, the Obama administration still must address the issues that are of great importance to consumers seeking to buy a home, lenders who seek to finance those purchases and the future viability of the U.S. mortgage market.
The independent FHFA has failed to advance the policies required by the Housing and Recovery Act of 2008 and the administration continues to stand pat, waiting for Congress to act legislatively. Treasury Secretary Lew and Michael Stegman, Senior Housing Policy Advisor to President Obama recently articulated this approach.
While the regulatory and safety and soundness authorities included in HERA meant the GSEs may not have actually required government support in the first place, these authorities have not been implemented due to the government control of the companies.
As a result, rather than holding more than the inadequate amounts of capital they held before the crisis, the GSEs have no capital at all. Their earnings are sent to the Treasury rather than retained to build capital and the GSEs are forced to rely on government support.
As Washington wrings its hands over the Federal Housing Administration’s 2% reserve number (it is backstopped by the federal government), Fannie Mae’s reserve capital is .06%. That’s not a typo: the FHA has 33 times the reserves of Fannie Mae, a $3 trillion company.
In the face of these realities, Washington is deadlocked and has shown little interest in meaningful legislative reform of the GSEs, even though they are the backbone of the mortgage finance system and chartered to ensure lenders have the financial and market liquidity to provide mortgage loans in both good times and bad.
A growing chorus of small lenders, affordable housing advocates, civil rights groups and capital market participants have asked that the GSEs’ regulator and conservator exercise the authorities provided him under HERA, and permit the GSEs to build adequate levels of capital so that they do not pose a risk to the public.
These same groups have also asked that once the conservator is satisfied the GSEs are adequately capitalized, the GSEs regulator then begin the process of releasing the GSEs – as required by HERA — from direct government control.
Instead, and in violation of HERA’s clear congressional intent, the independent regulator has failed to do so and appears not to be acting independently as required. Rather, he is taking directions from Administration officials who appear committed to gifting the GSEs’ business to our largest banks.
We suggest policymakers read the Washington Post article from January 2015 (The American Dream Shatters in Prince Georges County, Jan. 24, 2015) on how non-GSE loan programs bled the homeowners in Prince George's County from their home equity and savings in the bubble years.
It's a heartbreaking story of what will happen again if Wall Street and big banks get their way.
Under HERA, the FHFA has significant powers that would ensure the GSEs function more safely regardless of legislative reform. These include – but are not limited to – the ability to require that they be obligated to fund only well-underwritten and plain vanilla loans, and that they have only negligible exposures to the portfolios that allowed them to leverage their balance sheets.
The regulator also has the ability to prevent them from engaging in pricing their insurance in a manner that favors large lenders as before. Most importantly, unlike the regulatory authorities that existed between 1992 and the crisis, the Act provides the regulator with the clear authority to place the GSEs’ safety and soundness ahead of public policy goals while ensuring that the GSEs expand the commitment to affordable housing (but not where these goals imperil the safety of either borrowers or the GSEs.)
In other words, the regulator now is much stronger compared to what existed before 2008.
Additionally, under HERA, the Federal Government could continue to provide a line of credit from the Treasury to the GSEs, thus providing an explicit Treasury backstop. In 2008, the GSEs, the Conservator and Treasury had authorized and agreed that the government could levy a periodic commitment fee which, set at a proper level, would effectively pay for the existing federal backing without Congressional involvement. This authority removes the “implicit GSE backing” that bothers many.
One concern articulated by those opposed to recapitalizing and releasing the GSEs is that once they are free of conservatorship, the companies will “once again be forced to balance their public purposes against their shareholders’ interests.” This concern ignores all the other authorities granted to the FHFA in HERA that would prevent nearly all of the activities that imperiled the GSEs in the first place.
If FHFA instituted all of the changes required by HERA, it would become politically easy to move the narrow and limited legislation necessary to require that the GSEs pay for their very limited but explicit government catastrophic insurance policy that would allow the GSEs to continue to support the To Be Announced Market.
That line of credit would stand behind monumentally significant levels of capital, ensuring that the GSEs can absorb losses and that they will transfer much of the risks back into the private market and away from the taxpayer. Moreover, in crafting that narrow legislation, Congress would be in a position to legislate that the GSEs become like other such enterprises (water, gas, sewer and electric utilities). As such, the GSEs would become dividend-focused “granny stocks” with a fixed rate of return cap, a public utility commission and an investor base that is stable and long-term focused.
A second concern of opponents is that the recapitalization and release of the GSEs would create two new systemically important financial institutions with the result of potentially higher mortgage costs and less product flexibility. The reality is that the companies – in or out of conservatorship – are systemically important, highlighting the need to reduce the government’s exposure while ensuring their safety and soundness.
These opponents also ignore the reality that the underpricing of mortgage risks is precisely what caused the crisis. With its expanded authority under HERA, the regulator today is in a position to set pricing policy to create long-term safe lending, thus providing lenders with the liquidity necessary to allow the lowest possible level of increases in pricing while ensuring the safety and soundness of both borrowers and the GSEs securities, and fully supporting underserved borrowers.
Pretending that a fully private market can, or would, be interested in and able to adhere to those goals, is unrealistic.
Endless conservatorship of the world’s second-largest securities market has so many inefficiencies that they are impossible to list briefly. To quote one critic “Investors today see the Treasury capital pledge and take comfort from this ‘don’t ask, don’t tell’ form of explicit guarantee.”
Is this really a healthy, sustainable or efficient form of capitalism? Is it even capitalism?
This distorted and convoluted ownership structure has led to further distortions including efforts by Congress to siphon the insurance premium fees the GSEs charge lenders for the risks they are accepting and has sought to use them to fund sundry other federal priorities.
If this continues, the next generation of homebuyers – younger, more ethnically diverse, and hungry for mobility – will pay extra fees for other federal programs, certainly a generational “pay it backward” (to wealthier Baby Boomers).
At a time when Baby Boomers have record wealth and cheap mortgages, and young generations already struggle to make their way with student debt, this can’t be a desired outcome.
Importantly, but seemingly ignored by the Administration and some in Congress, small lenders remain fearful of the power of the large bank lobby, and know that until the GSEs are released, this power could find a way to move the mortgage market away from small lenders to their larger competitors.
As even some opponents of recapitalization and release of the GSEs acknowledge, the biggest banks are already succeeding – with the help of big-bank-funded think tanks – in pushing to expand the government backstop from a potential limited catastrophic risk insurance policy behind well-capitalized GSEs to a government backstop behind all conforming mortgage backed securities.
These too-big-to-fail banks are seeking access to a common securitization platform that the GSEs have been required to build and fund and, if allowed, would be in a position to turn the smaller lenders into their own third-party originators so that they could recapture their pre-crisis dominant position in the mortgage market.
The too-big-to-fail banks are also seeking the ability to use “risk transfer products” as a way to starve the GSEs of insurance premiums so that they can receive highly leveraged returns while leaving the GSEs with the catastrophic risk. There is not a capital markets expert who would not acknowledge that precisely in those periods in which private “loss-absorbing funding” would be necessary (in an economic downturn), that funding would vanish.
We saw this liquidity “run” during the crisis and there is no basis to expect next time to be different. As a result, rather than having well-capitalized secondary market liquidity providers standing by to lend (as the GSEs did in prior crises) the government would once again be on the hook for the risks borne by private market participants.
If the goal of Dodd Frank were to reduce the systemic risk and interconnectedness of these too-big-to-fail banks then the approach that many on the Hill and the largest lenders are pushing would undermine those efforts.
In finance, uncertainty has a real cost, and as the Urban Institute has noted, the general uncertainty around conservatorship has caused credit tightening beyond what is needed for safety and soundness. Why? Companies in conservatorship will always sub-optimize as executives keep their heads down to avoid running afoul of regulators, Congress, and the Treasury master upon whom they have to rely for the capital they have not been allowed to retain.
The result? Record high FICO scores at both GSEs, and lenders telling us that only pristine product can move. Fannie and Freddie have moderated formerly onerous put-back requirements, but the slow pace of these reforms have caused lenders — ones that did not go whole-hog for the distortionary loans products in the 2004-07 time frame, to have very tight overlays today.
Running the GSEs as recapitalized utilities, coupled with the authorities of HERA, would restore the balance — not too hot as before, but not too cold as now – that would allow credit decisions to flow in a safe and sound manner. This approach would also reduce the commingling of the utility-like goals of the secondary market with the growth and high-profit goals of primary market lenders.
After all, it was this commingling of functions that led to the GSEs mission creep, the race to zero between primary market lenders and the GSEs, and their dance toward the precipice. There is no reason to expect a different outcome if primary market players are handed the controls of the secondary market.
With a utility approach, the GSEs would have rigorous oversight, but not the stifling conservatorships where even small decisions have to go through multiple layers of reviews and bureaucracy. This would absolutely help first-time buyers and modest-income Americans who pay their bills and want a carefully underwritten mortgage granted in a reasonable amount of time.
And ending the conservatorships, combined with significantly higher capital than pre-crisis, would protect the affordable housing trust fund money, currently at risk because a GSE with no capital may need to take a new Treasury draw, thereby suspending trust fund payments.
Author Bethany MacLean said recently that Fannie and Freddie are “the last major institutions to remain in post-crisis uncertainty.” One principle nearly everyone agrees upon is this: no one wanted or favors endless GSE conservatorships.
If it were such a great idea, the government would have placed half the U.S. banking system into endless conservatorship during and after the crisis. It didn't.
Since the crisis of 2008, the nation’s wealthiest people — those with large savings accounts, stocks, and bonds — have been able to move on with their economic lives, making decisions and providing for their families and communities.
It’s time for those seeking the first rung of the economic ladder to be allowed to do the same.
