On Tuesday, June 10, Investors Unite hosted a panel discussion titled “Solutions For U.S. Housing Policy,”  for Members of Congress’ staff and other interested parties. Featured panelists included, Tim Pagliara, Executive Director of Investors Unite, Josh Rosner, bestselling author of Reckless Endangerment, and one of the nation’s foremost housing experts, Eva Clayton, former U.S. Rep., (D-NC); Ike Brannon, the President of Capital Policy Analytics; and, Gary Kalmanis, Executive Vice President and the Director of Federal Policy at the Center for Responsible Lending. Each touched on the role of Fannie and Freddie in preserving the American dream of homeownership. 

Josh Rosner gave a presentation focused on the best to approach housing reform and the potential consequences of unsound  housing reform. As part of his presentation, Rosner critiqued the recent efforts in Congress to reform Fannie Mae and Freddie Mac.  

Below is the full presentation from Rosner.

Fannie Mae, Freddie Mac: Rethinking U.S. Housing & Mortgage Finance Policy

Underlying Assumptions

  • Meaningful housing reform is possible in 2014 and doesn’t require Congressional action.
  • There are consequences for lack of reform, or improper reform.
  • Addressing GSE capital stack issues and reform go hand in hand.

Why did Fannie & Freddie Fail?

Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) improperly used their portfolios:

  • Beginning in the late 1990’s the GSEs employed the lower costs of funds, conferred by an implied government guarantee, to increase their leverage and invest in each other’s securities as well as investment grade rated private label securities;
  • Prior to that period, their portfolios were only employed for liquidity purposes; and
  • Such use of their portfolios increased leverage, risk and increased their pro-cyclicality and correlation with the primary mortgage markets.

Strong capital requirements can and should be fixed:

  • In the wake of the S&L crisis, as Congress was designing a new regulator and new oversight regime, for the GSEs, Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) successfully lobbied for and received the weak capital requirements embedded in the 1992 Act; and
  • How was it possible that GSE securities, backed by the companies’ weak balance sheets and underpriced guarantee fees, received the lowest Basel risk weighting when GSE capital standards were lower than any other financial firms?

The Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) improperly priced guarantee fees:

  • Historically, the GSEs priced guarantee fees appropriately for the credit risk they accepted;
  • In the years between 2003 and 2007, in an effort to retain market share, the GSEs began offering significant discounts on Gfees for large volume customers. Pricing began to diverge from consideration of risk; and
  • Guarantee fees should reflect underlying, loan-level, mortgage credit risk.

Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) were created as a public utility to support the secondary mortgage market but not regulated as such.

Fannie Mae, Freddie Mac a Dirty Term?

“Too Big to Fail” banks are the new GSEs.

  • A GSE is merely a firm that the market believes to have an implied or explicit government guarantee as a result of its size, interconnectedness or charter; and
  • As a result of Dodd-Frank’s different regime for the existence and resolution of our largest financial firms they, like the GSEs before them, are conferred the lower cost of funds that result from an implied government guarantee. As a result, market discipline of these firms is distorted and they have become increasingly able to compete with other firms based on this benefit rather than based on core economic competitiveness.

Banks and insurance companies are government sponsored but as long as they are disciplined by markets, able to be regulated and able to be resolved in failure, they pose no systemic risks.

Other examples of GSEs are less disconcerting and are government sponsored as a result of the official chartering. We recognize their unique status and regulate them as such.

  • Electric, Water, Gas and Sewer utilities are all examples of GSEs:

In return for their unique benefits, we subject these firms to a stringent regulatory regime which considers market power, requires meaningful capital and limits their growth by regulating their rates of return so that any returns above that rate to get plowed back into the building of capital; and

As a result, these GSEs, which are typically regulated by state and municipal authorities, have limited income available for excessive lobbying or legislative interference. This local market authority reduces the systemic risk of the failure of one of these firms.

What can or has been Accomplished without Congress?

FHFA has the authority to push forward with meaningful changes:

  • As a result of HERA, the FHFA has the authority to set capital stronger standards for Fannie and Freddie;
  • As a result of the original conservatorship agreement, their has been no defined method for Fannie Mae and Freddie Mac to repay the government and no definition of whether repayment would be based on a return of capital or return on capital; and
  • As a result of the Third Amendment to the PSPA Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) have no ability to build capital.

The GSEs need reduce their portfolios to serve only for liquidity purpose:

  • It is now widely recognized that the use of their portfolios for growth led to a blurring of lines between Fannie Mae and Freddie Mac intended secondary market purpose and the primary mortgage market.

This increased the pro-cyclicality of Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) and reduced their ability to support the primary market when it failed; and

  • Congress and FHFA have made meaningful strides toward this end.

Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) have raised their g-fees:

  • As a result, they are pricing credit commensurate with risk; and
  • If regulators or Congress took action to ensure adequate standards necessary to support a functioning private label market we would have a clearer basis on which to ensure adequacy of Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC)’ g-fees.

See full aritlce on Fannie Mae: Rethinking U.S. Housing & Mortgage Finance Policy in PDF format here via investorsunite.org