Nine Years Later: Addressing the Housing Finance Conundrum
Barbara Novick, Kevin Chavers, and Rachel Barry of BlackRock’s Global Public Policy Group outline the path forward for US housing finance reform from where we are now.
Current state of US housing finance
During the 2008 Financial Crisis (Crisis), Fannie Mae and Freddie Mac (collectively, the GSEs) were put into conservatorship by the Federal Housing Finance Agency (FHFA). Under this arrangement, FHFA can exercise decision-making authority over Fannie Mae and Freddie Mac. A key component of the conservatorship is the commitment of the US Treasury to provide financial support to Fannie Mae and Freddie Mac. The objective of these arrangements was to enable the GSEs to provide liquidity and stability to the mortgage market, while policy makers developed a longer-term solution.
Under the terms of the conservatorship, the GSEs are unable to grow a capital base. The government effectively takes the risks of the GSEs, and taxpayers could be on the hook for losses. Nearly a decade later, the GSEs remain in conservatorship, raising the question of: how do we move forward from here? In the past few months, US Treasury Secretary Mnuchin, FHFA Director Mel Watt, Federal Reserve Vice Chairman Stanley Fischer, Senate Banking Committee Chairman Crapo and others have called for housing finance reform. Tomorrow, the Senate Banking Committee will hold its second hearing in 2017 on this topic.
While some have interpreted these comments as a sign of immediate action, we believe this is the beginning of an extended dialogue. Under current law, the US Treasury is prohibited from selling stock in the GSEs until January 2018. In addition, GSE reform is only one item on a crowded public policy calendar.
What has changed since the Crisis?
The environment for real estate and housing finance has changed dramatically since the Crisis. Housing prices in most markets have largely recovered. The Consumer Financial Protection Bureau introduced new regulations that address both underwriting standards and mortgage servicing geared toward protecting borrowers. The Dodd-Frank Act introduced risk retention requirements for issuers of securitized assets. Rating agencies have significantly revised their ratings criteria and methodologies.
At the direction of the FHFA, the GSEs have undergone significant changes. These changes include reductions in the size of the GSEs’ portfolios, enhanced underwriting guidelines, increased guarantee fees, innovative structures for introducing private sector credit enhancement, and the ongoing development of a Common Securitization Platform and Single Security.
This backdrop is a more conducive environment for housing finance reform than at any time since the Crisis.
Framework for holistic housing finance reform
Prior to assessing various proposals, it is helpful to develop a framework for housing finance reform. We believe policy makers should take a holistic approach that addresses the need for a strong housing market and the need to protect taxpayers from future bailouts.
We start by acknowledging the important role of the government in residential mortgage markets. This role should be clearly defined and should include a government guarantee on mortgage-backed securities to support a deep and liquid market. Without government support, we believe credit would be more expensive and more difficult to obtain, which would negatively impact housing markets.
Transparency is a critical component of housing finance. This includes transparency regarding loan origination, securitization, and access to the secondary market. In addition, regulatory policies that recognize and respect the rights of investors are critical to attracting private capital to the housing markets, and policies that make clear a fiduciary standard for servicers and trustees would improve investor confidence. Special attention should be given to ensure utilization of best practices and clarity of policy and regulation.
Before Fannie Mae and Freddie Mac exit conservatorship, it is imperative to clearly determine their role in the housing finance system. The GSEs’ role as defined should be carefully monitored, clearly defined, and independent of other functions in the housing finance system.
Finally, a safe and orderly transition to a new system is critical. An orderly transition is imperative to avoid disruption to the housing finance market and to ensure the continuity of liquidity in this market. This requires (i) clear and simple fungibility between current securities and new securities, if they take on a different form; (ii) a full faith and credit guarantee on the current securities; and (iii) an appropriate transition period.
Housing finance reform proposals
In order to meet the dual objectives of supporting the housing sector and protecting taxpayers, housing finance reform must address a number of key areas, including the appropriate level of private capital, how to achieve that level of capital, and the appropriate level of cross-subsidization across an array of credit and geographic cohorts.
Over the past few years, a number of housing finance reform proposals have surfaced. On one end of the spectrum, some proposals envision almost zero government involvement in housing finance. On the other end, some call for a return to the pre-Crisis public-private GSE structure. Both of these extremes fail to meet the dual goals of effective reform.
A series of proposals in between these two extremes call for some form of express government guarantee at the mortgage-backed security level and propose mechanisms to deliver it, as well as mechanisms to lay off some credit risk in the capital markets. While there are different ways to design the infrastructure of a new housing finance system, we believe these are necessary components of a viable framework for reform.
We recommend the adoption of the policy that will prove the least disruptive with the greatest ease of execution and fungibility between the current and any future state. For a more detailed look at BlackRock’s perspective on US housing finance reform as well as relevant disclosures, click here.