More GSE Reform Proposals Offered. Reduced Loan Limits Inevitable

by devteam February 10th, 2011 | Share

ThernHouse Capital Markets Subcommittee held a hearing on Wednesday on reformingrnFannie Mae and Freddie Mac.  Testimonyrncame from representatives of three conservative “think tanks” and arnsingle progressive one.  The first threernspeakers presented outlines for reform that had the common theme ofrnprivatization and many similar specifics. rnThe fourth advocated for continued government involvement and devotedrnmuch of her testimony to contradicting premises of her fellow panelists. </p

Mark A.rnCalabria, Ph.D., director of Financial Regulation Studies at the Cato Instituternsaid the need for reform of the two government sponsored entitiesrn(GSEs) is beyond dispute and  there will be divisions over the substance ofrnsuch reform but there are steps which Congress and the Administration must takernimmediately to protect the taxpayer and “reduce the perverse incentivesrnthat permeate our financial system.”</p

Calabriarnand Anthony Randazzo, director of economic research at the Reason Foundationrnboth urged the government to act quickly to change the role of the FederalrnHousing Finance Administration (FHFA) from conservator of the GSEs to receiverrnwhich would allow losses to be imposed upon the GSEs’ debt holders rather thanrnthe taxpayers.  Such a receivership wouldrnnot end the GSEs as the Housing and Economic Recovery Act (HERA) specificallyrnprohibits FHFA from immediately terminating the enterprises’ charters and wouldrngive Congress sufficient time to deliberate reform. </p

Placingrnthe GSEs in receivership would help to lessen the perception that certainrnentities are too big to fail. rn”If we are unwilling to take Fannie Mae into a receivership,”rnCalabria said, “then most market participants will conclude that we wouldrnalso be unwilling to take Citibank or Goldman Sachs into a receivership.”</p

Anotherrnobjection to receivership is that it would impose losses on creditors, most ofrnwhich are also financial institutions and this might cause some to fail orrnexperience financial stress but he foresees few resulting bank or thriftrnfailures as they hold MBS.  Subordinaterndebt would likely be wiped out so Money Market Mutual Funds might incurrnsignificant losses as would foreign banks.</p

Onerninevitable element of this transition should be a gradual step-wise reduction in thernmaximum loan limits for the GSEs and FHA. rnThis would shift higher mortgage costs as well as the reduction inrnpotential tax burden to higher income households.  The current “jumbo” loan market -rnloans above $729K – is approximately $90 billion.  Reducing the loan limit to $500K wouldrnincrease the size of the jumbo market to around $180 billion, an amount thatrninsured depositories with excess reserves of over $1 trillion and an aggregaternequity to asset ratio of over 11 percent should have no trouble absorbing.  Moving more of the mortgage sector to banksrnwould also put some capital behind the market which at present does not exist. This step seems inevitable. </p

Calabriarnsuggested other immediate changes in preparation for more comprehensive GSErnReform.  </p<ul class="unIndentedList"<liTransitionrnall GSE employees to the government pay scale as quickly as possible.</li<liCongressrnshould examine the agreements reached between the GSEs and banks in regard tornloan repurchases and GAO should audit them.rnFunds recovered should be used for off-setting taxpayer assistance tornthe GSEs</li<liCongressrnshould establish a "recoupment fee" on all mortgages purchased by thernGSEs. A 1 percentage point per unpaidrnprincipal balance of loans purchased would raise at least $5 billion annuallyrnand would have the additional advantage of reducing the competitive advantagernof the GSEs.</li<liWholernmortgage loans currently require a 50 percent risk-weighting under Basel IIrnwhile GSE debt only requires a 20 percent.rnThe result is that the overall system holds only about 40 percent of thernequity behind the mortgage market as it would otherwise. Congress should gradually eliminate thernpreferential treatment of the GSEs by bank capital standards; this would requirernthe banking system to increase capital by approximately $24 billion.</li<liGoingrnforward the GSEs should be limited to purchasing only those mortgages that meetrnthe eventual definition of a qualified residential mortgage under thernDodd-Frank Act and should be immediately be allowed to purchase only mortgagesrnfor primary residences, with a maximum LTV of 90 percent and a credit qualityrnindicating a projected delinquency rate of less than 5 percent.</li<liThernscheduled reduction of GSE retained portfolios should be accelerated and thernportfolios limited to mortgage-related investments with minor provision forrncash and treasuries.</li</ul

Randazzo’srnlist of 10 intermediate actions contained many of the same suggestions but alsornurged a 20 percent minimum downpayment for GSE mortgages and an end to allrnaffordable housing goals.</p

AlexrnPollock, resident fellow of the American Enterprise Institute suggests that anrnultimate aim for the GSEs would be to divide them into a “bad” bankrnwhich would be put into a liquidating trust, a “good” bank whichrnshould be privatized and the remaining governmental activities of deliveringrnsubsidies and non-market loans merged into the Department of Housing and UrbanrnDevelopment (HUD) and a five-year sunset be set for the GSE charters.  He echoed earlier suggestions of reducingrnconforming loan levels and prohibiting double leveraging of the GSEs by banksrnand suggested additional intermediate steps while awaiting permanent reform. </p<ul class="unIndentedList"<liEnablerncovered bonds as an alternate long-term mortgage funding option. Legislation is required to protect therncovered bond holders' rights to the relevant collateral, but with covered bondsrnthe issuing bank will have 100 percent "skin in the game."</li<liBringrnGSE capital requirements up to those of national banks.</li<liMandaternthe run-off of the GSEs' investment portfolios.</li<liAccountrnfor GSE debt on the government's books.</li<liProhibitrnfuture lobbying by the GSEs</li<liEliminaternall GSE affordable housing goals and transfer any such goals to HUD.</li<liRequirerna one-page mortgage disclosure form for all GSE-guaranteed loans.</li<liConsiderrnrequiring GSE approval for the addition of second liens.</li<liRemoverntaxpayer guarantee of GSE subordinated debt.</li</ul

SarahrnWartell, Executive Vice President, Center for American Progress said a newrnhousing finance system should be based on five principles; </p<ul class="unIndentedList"<liLiquidity. Investors must have the confidence to deliverrnmortgage credit for both ownership and rental options in every community,rnthrough large and small lenders, and regardless of economic conditions.</li<liFinancialrnstability. Mortgage lending in inherentlyrnpro-cyclical sources of countercyclical liquidity are required so to stabilizernthe markets and economy. </li<liTransparencyrnand standardization. Underwriting andrndocumentation standards must be clear and consistent so consumers, investors,rnand regulators can accurately assess and price risk and institutions can bernheld accountable for maintaining an appropriate level of capital. </li<liAccessrnto reasonably priced financing for both homeownership and rental housing.</li<liSupportrnfor the best interests of borrowers and consumers and protection from predatoryrnpractices.</li</ul

Wartellrnsaid that “taking some of the steps recommended by other panelists wouldrnserve the goals of our system badly.” rnRestoring a private market system will take time.  There has been only one private labelrnsecuritization deal since the beginning of the financial crisis three years agornand it consisted entirely of 5-year jumbo ARMS of extremely high quality.  “It is hard to imagine private-labelrnsecuritization coming to a scale to take any significant part of the conventionalrnmarket in the near future.”  Sherncited as reasons the current incomplete rulemaking surrounding Dodd-Frank, thernlack of investor confidence in private label securities, the need to look atrnservicing standards, and the comparative pricing advantage of GSE-backedrnlending.</p

Therernshould not be an either/or choice between the status quo and radicalrnprivatization, she said.  A third optionrnwould be a limited government guarantee of MBS. rnPrivate investors could pay into an insurance fund along the lines ofrnthe FDIC fund to protect taxpayers.</p

ThernCenter supports a reduction in loan limits so as to focus the governmentrnbackstop on the lower part of the market but not until the private market isrnpositioned to take over the higher end. rnTo reduce limits too soon will hamper the ability to sell and ultimatelyrnthe value of homes.  “In such arnfragile economy, policy-induced home price declines seem unwise.”</p

Wartellrnsaid she shares the goal of reducing taxpayer losses but fears some of thernproposals presented at the hearing would have the opposite effect.  Shutting down the GSEs just as their assetsrnare improving and losses are declining would cut off future dividends under thernpreferred stockholder program and the proposal to rapidly liquidate the GSErnportfolios could also have the unintended effect of depressing the market andrnreducing recoveries for taxpayers while benefitting investors.  Selling assets gradually as now intended isrnmore likely to maximize recoveries.</p

Itrnis difficult to foresee what the housing market might look like under a systemrnwithout government participation Wartell said. rnIn the event that private forces are able to finance the $10 trillionrnplus of mortgage debt, it is difficult to see how their obligations would notrnbe considered systemically important.  Insteadrnof a purely private market, we might “create a new set of implicit,rnunmonitored, and unpriced government guarantees.”</p

The Obama administration will unveil its proposals for changes to housing finance giants Fannie Mae and Freddie Mac on Friday.

All Content Copyright © 2003 – 2009 Brown House Media, Inc. All Rights Reserved.nReproduction in any form without permission of is prohibited.

About the Author


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

See all blogs


Leave a Comment

Leave a Reply

Latest Articles

Real Estate Investors Skip Paying Loans While Raising Billions

By John Gittelsohn August 24, 2020, 4:00 AM PDT Some of the largest real estate investors are walking away from Read More...

Late-Stage Delinquencies are Surging

Aug 21 2020, 11:59AM Like the report from Black Knight earlier today, the second quarter National Delinquency Survey from the Read More...

Published by the Federal Reserve Bank of San Francisco

It was recently published by the Federal Reserve Bank of San Francisco, which is about as official as you can Read More...