Housing Finance Reform Assumptions Refuted by Congressman Garrett

by devteam February 9th, 2011 | Share

The newrnChairman of the House Financial Services Subcommittee on Capital Markets andrnGovernment-Sponsored Enterprises has invoked what he called “The CantorrnRule” as a framework for reforming the U.S. housing finance mechanism.  </p

Representative Scott Garrett (R-NJ) shared with attendees at the American Securitization Forum (ASF) Conference on Monday what Majority LeaderrnEric Cantor tells House members to always ask themselves, ‘Are my efforts addressingrnjob creation and the economy; are they reducing spending; and are theyrnshrinking the size of the federal government while increasing and protectingrnliberty? If not, why am I doing it? Why are we doing it?’ </p

“Applying the Cantor Rule to the GSEs,” Garrett said, “thernquestion I believe needs to be answered first is – What are the things we canrnbe doing right now, this very instant to: 1.) Protect taxpayers; 2.) End thernbailouts; 3.) Get private capital back in our mortgage markets; and 4.) Decreaserngovernment exposure to housing?  Irnbelieve these four objectives should be the driving forces in our initialrndecisions regarding GSE reform legislation.”<br /<br /Garrett said, while there are countless ways to address these goalsrnlegislatively there are four specific areas that would be good places to start.</p

First, the combined retained portfolios of Fannie Mae and Freddie Macrn(the GSEs) are roughly 1.5 trillion. rnWhile under the conservatorship agreement these portfolios are required tornshrink by a small percentage each year to a set level, it should happen faster.  There is a significant amount of interestrnrate risk in the portfolio and, as the rate environment becomes more volatilernit will become increasingly difficult to hedge such a large portfolio againstrnthose movements.  There are also significantrnunrealized gains in the portfolios that should be recognized.</p

Halfrnof the portfolios are agency MBS, one-quarter is non-agency MBS and the balancernincludes all types of mortgage loans. rnSome of these assets can be sold off more quickly; there is a specificrnmarket for each of these assets and each portfolio component should be lookedrnat for the best way to wind it down quickly. Selling assets quickly, Garrettrnsaid, may have effect their price but if it happens faster it will reducerntaxpayer risk.  He said there were probablyrna number of people in his audience who would provide a market for some of thernassets.<br /<br /Next, both of the GSEs should be put on the federal government’s budget. Thisrntransparency will increase budgetary pressure and will force Congress and thernAdministration to deal with the GSEs “and not let them continue onrnexisting in perpetuity.”</p

“Another area that should be addressed Garrett said, is the Conforming LoanrnLimit.  To afford a house of almost $730,000, the current limit, a familyrnwould need to earn roughly a quarter of a million dollars. “These arernthe same people that the president wants to raise taxes on.  It doesn’t make much sense to raise taxes onrnthose families because they are too ‘rich’ and then turn around and have therngovernment subsidize them when they want to buy a house!<br /<br /The fourth area Garrett pointed to as a starting place for change is the AffordablernHousing Goals, which he called one of the main causes of the GSE’srncollapse.  These, he said, should bernabolished.</p

“It is absurd that these two entities, under federal government conservatorshiprnand hemorrhaging billions of taxpayer dollars, have their conservatorrnpublishing new affordable housing goals for them to hit. The only goal theserntwo entities should currently have is to reduce their burden on the Americanrntaxpayer.”<br /<br /Turning to the future of the housing finance market, Garrett stressed that,rnwhatever shape it takes, securitization will play an integral and vital role. Thererncannot be a market of over $11 trillion such as in the U.S. without securitization.  There is not enough capital in the bankingrnsystem without it and currently 75 percent of the market is funded by thernsecondary market and MBS investors.   "But, while there are a wide variety ofrnpositions on the future of housing finance, two things everyone can agree on isrnthat having the federal government continue to underwrite 95% of our nation'srnmortgage market and having the FHA specifically insure 50% of new originationsrnis completely unsustainable.<br /<br /Garrett said that he wanted to be very clear that he is firmly committed to arnpurely private U.S. mortgage market over time – free of government guaranteesrnand subsidies. "I realize that this will not be an easy or immediate goal butrnit is one I feel strongly about – especially given the role that governmentrninvolvement in the mortgage market played as a central cause of the financialrncrisis."<br /<br /People who support a continued government role raise concerns about a purelyrnprivate market, Garrett said. But there are just as many concerns with any modelrnthat includes government support.  <br /<br /He refuted “eight of the central claims and assertions made by what somernrefer to as the ‘Housing Industrial Complex.” rn</p<ul class="unIndentedList"</ul<ol

  • The 30-year fixed rate mortgage product cannot survive without arngovernment guarantee: “Given the fact that there was a fairly robust 30-year jumbo market beforernthe crash and that you can get a 30-year fixed jumbo today, I don’t believernthat assertion is correct.” Prices would presumably increase and down payments would be higher but Garrettrndoes not feel that is necessarily bad as newer, more consumer friendly productsrnmight emerge. Other countries that have higher homeownership ratesrnsurvive and even thrive without the 30-year fixed and there may be other waysrnborrowers could access options in the private sector to hedge against interestrnrate risk. “It appears to me, Garrett said, that this statement is used more torngain political leverage in the debate rather than to truly look at itrnobjectively.” </li
  • The government can easily price the tail or catastrophic credit riskrnassociated with the mortgage market: Garrett citied the Deposit Insurance Fund, National Flood Insurance Program, andrnthe Pension Benefit Guaranty Corporation as three examples that the governmentrncannot effectively price for risk. Ifrnpoliticians are setting the price, he asked, would politics, which is veryrnpro-cyclical, inevitably get involved? </li<liThe To-Be-Announced (TBA) market must be kept viable and the only wayrnto ensure its existence is to have a government guarantee: The TBA market has provided benefits to consumers by allowing them to lock-inrninterest rates earlier, he said, it mustrnbe remembered that the TBA market is a product of the government guarantee, notrnthe other way around. There are otherrnways to achieve these benefits such as a more robust interest rate futurernmarket or common underwriting standards.</li<liThere should be a government guarantee because the government always,rneventually, steps in if there is a problem: He said he didn’t disagree that the government can’t help itself fromrnintervening in a number of areas of the free market, but if you set up arnspecific system and structure to allow the government to step in he expects thernchances they will do so will be much greater?rnAlso it may be that a government guarantee leads to more moral hazard.</li<liRates investors are only willing to accept interest rate risk and do notrnwant to take credit risk: We must have rates investors interested in our mortgage market to achieve a significantrnamount of liquidity but there may be ways to minimize their credit risk throughrnstructure or through sound and strict underwriting standards that havernperformed historically at quantifiable levels regardless of market conditions. Garrett said he has been working on covered bond legislation and that last yearrnU.S. investors bought $22 billion of foreign covered bonds. Eighty percent ofrnthese investors were rates buyers so Garrett believes they can be an importantrncomponent of the broader market if legislation is passed.</li
  • National Mortgage Servicing Standards should be included in the finalrnversion of the Qualified Residential Mortgage (QRM) definition: The argument, Garrett said, is that securitization will not function properlyrnagain unless investors feel that the problems in the mortgage servicing area willrnbe addressed. This issue was neverrnmentioned during debates leading to the Dodd-Frank Financial Reform Act. Also, because the QRM definition applies torncharacteristics which exempt securities from risk retention at origination,rn”how would a failure in servicing, which is done over the duration of arnloan, impact the security that has already been exempted? While the topic is important, it is one thatrnregulators should not unilaterally address without property authority from Congress.</li<liAny policy decisions should weigh the impact on affordable housing: “I believe that, if there is to be any government assistance to homeownership,rnit should be limited to first-time homebuyers or rental housing and that thernassistance should be on-budget and appropriated annually by Congress. “Many supporters of affordable housing liked having it funded “off-balancernsheet” and many providers of affordable housing funds use it to give themrnadditional political leverage in other areas.” </li<liThe government has to play such a large role in our mortgage marketrnbecause the private sector refuses to: Garrett asked whether the private sector is avoiding the market because itrndoesn’t want the risk or because it is being priced out by the government’s involvement. Other asset-backed markets are functioningrnwithout government support. Also, we already have close to $100 trillionrnof unfunded liabilities, how are we supposed to take on the credit risk of thernentire housing market?<br /<br /</li</ol

    It will be a top priority of mine, Garrett said, to answer each one ofrnthese questions more fully and develop a consensus on the future of the U.S.rnhousing finance market.

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    Steven A Feinberg (@CPAsteve) of Appletree Business Services LLC, is a PASBA member accountant located in Londonderry, New Hampshire.

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