Destination Unknown: The Future of GSEs In America


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Destination Unknown: The Future of GSEs In America

  1. 1. The Future of GSEs In America Anthony B. Sanders Senior Scholar Mercatus Center at George Mason University
  2. 2. Whither Fannie Mae, Freddie Mac, and FHA?• Best analogy is a taxi cab medallion • License to operate with government guarantee • Only FHA, Fannie Mae and Freddie Mac have them• Cost of the medallion? • NY City Taxi Cab Medallion recently sold for $1 million • The cost of the government guarantee medallion is far more expensive (affordable housing goals) • All three medallion holders are chasing affordable housing goals (aka, risky lending)• Are Government subsidized mortgage rates the “other” entitlement along with mortgage rate deductions?
  3. 3. Should There Be A Medallion?• No, the private market should price risk rather than government• Policy since Clinton (National Homeownership Strategy) has so devastated the housing finance system (low down payment mortgages, streamlined underwriting, aggressive marketing, councilors, etc.) that we have government capture of mortgage markets: – >90% government control of residential securitization – Add HECM and student loan capture … – Need to avoid creating a 100% FHA market!
  4. 4. The Result of Crowding Out By Government“There’s simply no such thing as a nonguaranteed housingfinance market, other than in ideological fantasies.” AdamLevitin, Georgetown University, Sept, 2011•This sentiment is echoed by many in the finance industry – That is, no one will buy our MBS without a government guarantee – If this is correct, then SOMEONE has to hold the medallion – The question is WHO and HOW MANY?•Spreads between GSE 30 yr MBS and 10 yr Treasuries revealthat Fannie/Freddie MBS are just Treasury substitutes. – Private label MBS could attract more investors with higher yields
  5. 5. Their Talking Points• Product Availability Lower – 30 Year, fixed rate, callable mortgage will not exist FALSE • Banks continue to originate and hold 30 year FRM – Homeowners will have to take more risk, will not be able to match duration of their largest asset GOOD • LESS TEMPTATION TO SPECULATE AND GO FOR THE MAX – 3-5 year ARMS with prepayment penalties will be the norm, putting more risk upon households GOOD • ARMS FORCE BORROWERS TO CONSIDER HIGHER PAYMENTS IN FUTURE, WILL CONSUME LESS HOUSING (DON’T CONFUSE THE ARM BEHAVIOR IN THE BUBBLE WITH NORMAL BEHAVIOR) – Much larger TBTF banking system will be needed, with government support in another form BIGGER THAN FANNIE AND FREDDIE? • NOT TRUE. THERE IS NO REASON TO BELIEVE THIS ARGUMENT.
  6. 6. Their Talking Points• Level of Rates Higher – Level of mortgage rates will be 100 to 250bp higher PROBABLY TRUE • Historically, the jumbo-conforming spreads has been 30 basis points, back to Clinton Spread history shows that private RMBS market had more volatile rates SO? • Why should taxpayers subsidize lowering rate volatility, particularly when The Fed is already doing
  7. 7. Their Talking Points• Costs to Society will be higher – Taxpayer bailouts will be more expensive AS OPPOSED TO THIS MELTDOWN? • NO REASON TO BELIEVE THIS IS TRUE – Homeownership will be lower, fewer good borrowers will qualify PROBABLY • CLINTON PUSHED HOMEOWERNSHIP SO HARD WE BROKE THE SYSTEM. WHAT’S WRONG WITH RENTING? – Labor mobility will be lower UNLIKE PEOPLE TRAPPED TODAY? • MANY PEOPLE ARE TRAPPED IN THEIR HOMES THANKS TO GOVERNMENT HOUSING POLCIIES ALREADY – Main monetary policy transmission mechanism will be diminished NOT TRUE • MORTGAGE REFIS ARE FASTER ON PRIVATE LABEL MBS, SLOWEST ON GINNNIE MBS
  8. 8. Back To The Pre-Securitization Days• No securitization, bank balance-sheet lending only – Regulators feel banks are already too exposed to real estate – But banks have staggering amounts of reserves available (although “sterilized” by Fed – Regulatory knot (Fed, FDIC, OCC) – too much regulation• But Dodd-Frank restricts bank lending – QRM definition is restrictive and only applies to originators, not to medallion holders (Fannie Mae, Freddie Mac, FHA – Even if something is done with the GSEs, Dodd-Frank represents a significant hurdle to repairing the mortgage market• Perhaps 50% of $10 trillion mortgage market – If you want the mortgage market to shrink, stop securitization (Warning: unintended consequences alert!)
  9. 9. Securitization• The devastation caused by well-intended national housing policies may have left us with no choice: a medallion is required• But WHO gets to hold the medallion if that is the path that we choose? – All banks (originators) hold limited medallion (risk sharing with government) – Convert Fannie/Freddie to reinsurance companies with NO retained portfolios (Do we need two?) – FHA? Difficult to control and massively inefficient. Shut them down.• To prevent a repeat of history, I suggest a cooperative form of ownership among originators – Even a mutual approach to ownership could work, but less cooperative (utility) would remove the “hog trough” problem
  10. 10. Risk Sharing Approach Between Government And Originators  Level 1: Quality Mortgage Loans  Minimum Down Payment, no second liens Down payment 20%  Strict UW Standards and Appraisal Requirements  Full Recourse to borrower (State laws?) First loss to Originator  Level 2: Separately Capitalized Originator Insurance Initially 5%  Subordination based on extreme stress scenarios (going to 30%)  Standardized structures capitalized by valuable assets  Non-rescindable insurance contract or subordinate bonds  Originator earns profits over time instead of booking it all upfront. Capital in SPV accrues in tax advantaged way.  Reps and Warranties hit this first , no debate, no delay Reinsurance from  Level 3: Government Medallion Wrap Gov’tValue  Bond holder looks to Federal government for full faith and Initially 95%of credit guarantythe (going to 70%)  DANGER: Potential problem with Administration and Congress easingloan the wrap rules (such as 3.5% down payment, 5% first loss to originator and 95% to taxpayers (aka, government). And this is a SECOND BEST SOLUTION, not the best solution (no government medallion).
  11. 11. Cooperative Structure: More Detail
  12. 12. Preferred Futures of GSEsPreferred Solution•Bank portfolio lending•Securitization with no medallion (government guarantee)•No affordable housing mission*Second Best Solution (most likely)•Partial medallion to all originators (risk sharing with government)•Cooperative or mutual ownership structure•Fannie/Freddie as reinsurance companies•No affordable housing mission*Third Best Solution•Keep Fannie/Freddie in place, but with strict oversight (Warning: danger!) – No retained portfolio, transparency on loan purchases, no affordable housing mandates, etc.Multifamily?•Spin off from Fannie/Freddie, use cooperative structure, no medallion – Already have FHA/GNMA programs*Note: HUD still retains rental programs, so affordable housing mission is on balance sheet.
  13. 13. 10 Year Phase In•Whether we go with a cooperative or mutual ownership structure withFannie/Freddie as reinsurance companies, or some other future, I suggestTAKING IT SLOW and PHASING IN CHANGES.•The last time we accelerated housing policy (1992-1999) we moved too fastand created a monster. – Federal Housing Enterprises Financial Safety and Soundness Act of 1992 • Act also established HUD-imposed housing goals for the financing of “affordable housing,” housing in central cities, and housing in rural and “other underserved” areas. HUD has periodically raised the goals. – National Homeownership Strategy: Partners in the American Dream” – 1995 – Removal of Capital Gains Taxation on Housing – 1997 – Financial Services Modernization Act of 1999•Taken together, these well-intended policies had horrible consequences – Let’s provide STABILITY and take our time rather than rushing for the lifeboats on a sinking ship
  14. 14. 10 Year Phase In Non-Agency MBS Issuance Has Disappeared
  15. 15. But Private Label MBS Are Still Issued
  16. 16. U.S. Homeownership Rate—The Great Leap Forward
  17. 17. Home Price History
  18. 18. Fed Policy and Home Prices
  19. 19. Growing Bank Holdings of Agency MBS
  20. 20. MBA 30 vs FNMA Current Coupon – Spread Widened in Dec 2008
  21. 21. Different View of Bank Rates vs Fannie CC Rate
  22. 22. Jumbo-Bank Rate 30 FRM Spread Pre and Post Crisis
  23. 23. Fannie 30 CC vs 10 yr Treasury CMT 90 Basis Point Spread
  24. 24. TBA Shows Fannie 30s Barely Above 10 yr Treasuries
  25. 25. Example of Fannie Multifamily Deal
  26. 26. Sterilized Bank Reserves
  27. 27. Clinton-era Mortgage Rates
  28. 28. References/Additional Reading• FHA’s Instant Undertow Mortgage –• National Homeownership Strategy and the Clinton Housing Trifecta –• Dangers of the Administration’s 14 Loan Modification Programs –• FHFA and Principal Reductions –• Krugman on Bush Creating the Housing Bubble –• TBA for Private Label MBS? –• Reuter’s Mortgage Write Down Calculator –• Fannie/Freddie had 30%-40% share of “subprime” from 2001-2008 –• Do We Need the 30 year Fixed-rate Mortgage? –• Andrew Davidson, GSE Reform: Risk Sharing and Cooperatives, 2012. Paper at Federal Reserve of Atlanta.
  29. 29. Contact Information• GMU Web:• Mercatus Web:• Email:• Phone: 703-993-1326
  30. 30. Destination Unknown: The Futureof GSEs in America Dr. Arnold Kling Mercatus Center at George Mason University Presentation in Washington, DC May 2, 2012
  31. 31. The Way Forward: MortgageFinance in a Post-GSE World Lawrence J. White Stern School of Business New York University Presentation in Washington, DC May 2, 2012
  32. 32. “The shapers of the American mortgagefinance system hoped to achieve the securityof government ownership, the integrity oflocal banking and the ingenuity of WallStreet. Instead they got the ingenuity ofgovernment, the security of local banking andthe integrity of Wall Street.” David Frum, National Post, July 11, 2008
  33. 33. “..the GSEs play an extraordinarily successfuldouble game…[telling] Congress and the newsmedia, ‘Don’t worry, the government is not onthe hook’ – and then turn around and tell WallStreet, ‘Don’t worry, the government really is onthe hook.” Richard Carnell, Senate testimony, February 10, 2004
  34. 34. “It’s only when the tide goes out that youlearn who’s been swimming naked.” Warren Buffet
  35. 35. Deep Throat* (Hal Holbrook): “Follow the money.”Bob Woodward (Robert Redford): “What do youmean? Where?”Deep Throat: “Oh, I cant tell you that.”Bob Woodward: “But you could tell me that.”Deep Throat: “No, I have to do this my way…” “All the President’s Men” (1976)*Now known to be Director: Alan J. PakulaW. Mark Felt, Writer: William GoldmanDeputy FBI Director
  36. 36. Overview•Housing and subsidies•The failures of Fannie and Freddie•How to avoid future bailouts of the housing finance system•What about “affordability” and “accessibility”?•What about the 30-year fixed-rate mortgage?•Where will mortgage finance come from?•How to get from here to there•Other needed long-run reforms•Conclusion
  37. 37. Housing is heavily subsidized•Fannie & Freddie•FHA, VA, USDA, Ginnie•Income tax deductions for mortgage interest, state & localgovernment taxes•Capital gains exclusion•Subsidies for builders•Direct provision by government (“public housing”)
  38. 38. Consequences of heavy subsidy•Households buy more house! – Larger, better appointed houses on larger lots•Because of subsidies, U.S. housing stock is 30% larger;U.S. GDP is 10% smaller•Income tax deductions and exclusions mostly benefitupper income households•Effects on home ownership rates are modest (at best) – Subsidies for purchase mostly encourage households that would have bought anyway to buy bigger – Where is the social benefit in that?
  39. 39. The Failures of Fannie & Freddie•Too many high-risk mortgages were held and securitized – This began in the mid to late 1990s•Not enough capital – Only 2½% capital for mortgages held in portfolio • Supposed to cover credit risk and interest-rate risk – Only 0.45% capital for securitized mortgages • Supposed to cover credit risk – Banks and S&Ls are required to hold 4% capital just to cover the credit risk on mortgages!•The U.S. Treasury’s capital contribution so far: more than$180 billion
  40. 40. How to avoid future bailouts of the housing finance system•Require more capital for “systemically important financialinstitutions” (SIFIs)•If size generates negative externalities, put a tax on size – Much better than the sledgehammer of a forced breakup•Cut back on government guarantees – Limit guarantees to FHA, VA, USDA, Ginnie – Be clear-eyed that the focus is to help (properly screened) low/ moderate-income first-time home buyers – Expect on-budget moderate losses – Eventually replace with down payment assistance
  41. 41. How to avoid future bailouts of the housing finance system•Require more capital for “systemically important financialinstitutions” (SIFIs)•If size generates negative externalities, put a tax on size – Much better than the sledgehammer of a forced breakup•Cut back on government guarantees – Limit guarantees to FHA, VA, USDA, Ginnie – Be clear-eyed that the focus is to help (properly screened) low/ moderate-income first-time home buyers – Expect on-budget moderate losses – Eventually replace with down payment assistance
  42. 42. What about “affordability” and “accessibility”?•“Affordability” is a code word for widespread subsidy – Income redistribution is best done through income transfers, not through subsidizing specific goods – The pre-2007 differential between conforming (F&F) loans and jumbos was only approximately 25bp (0.25%)!•“Accessibility” is a code word for mandates – Why does a profitable service need to be mandated? – And if it’s not profitable… – If the real issue is discrimination, then address that directly and prosecute vigorously
  43. 43. What about the 30-year fixed-rate mortgage?•Jumbo (unguaranteed) 30-year fixed-rate mortgages havebeen and continue to be available•The major issue with 30-year fixed-rate mortgages isinterest rate risk; but government guarantees cover onlycredit risk•Insurance companies and pension funds are natural buyersfor long-lived obligations – But pre-payments are a problem•Pre-payment fees need to be part of the answer – The “free” pre-payment option adds about 50bp to mortgage interest rates
  44. 44. Where will mortgage finance come from?•Expanded depository lending – Depositories held 30% of mortgages in 2007 (not including MBS) • Despite all of the subsidies/advantages for F&F – Covered bonds may provide modest help•Simplified, clarified private-label securitizations – Simple tranche structures – Insurance companies and pension funds are natural buyers • Life and P/C insurance companies: $6.7 trillion in assets • Private, state, local, federal pension funds: $10.5 trillion in assets • Less than 6% of these assets are currently held in MBS
  45. 45. How to get from here to there•Fannie & Freddie plus FHA/VA/USDA/Ginnie currentlyaccount for over 90% of mortgage originations – They are crowding out private-sector involvement•Start winding down/selling off F&F’s mortgage portfolios•Reduce the F&F conforming loan limit by 10% per year – Reduce FHA’s limit by 10% per year until it is 20% below median house prices•Raise guarantee fees by 5bp per year
  46. 46. Other needed long-run reforms•Cut back on housing subsidies generally – Start portraying a house as just another asset, not special – Replace lending subsidies with down payment assistance – Make renting respectable•Reduce resource distortions that make housing more costly – Local land-use zoning – Restrictions on lumber imports from Canada•Make recourse the norm in mortgage lending Will reduce strategic defaults Will discourage excessive leveraging•Give the primary lender the power to approve a second lien – This is standard in commercial lending
  47. 47. Conclusion•Housing and housing finance are important•Good policies can make a big difference – So can bad policies•Sooner is better than later