Housing Finance Reform Assumptions Refuted by Congressman Garrett

The new Chairman of the House Financial Services Subcommittee on Capital Markets and Government-Sponsored Enterprises has invoked what he called "The Cantor Rule" as a framework for reforming the U.S. housing finance mechanism. 

Representative Scott Garrett (R-NJ) shared with attendees at the American Securitization Forum (ASF) Conference on Monday what Majority Leader Eric Cantor tells House members to always ask themselves, 'Are my efforts addressing job creation and the economy; are they reducing spending; and are they shrinking the size of the federal government while increasing and protecting liberty? If not, why am I doing it? Why are we doing it?'

"Applying the Cantor Rule to the GSEs," Garrett said, "the question I believe needs to be answered first is - What are the things we can be doing right now, this very instant to: 1.) Protect taxpayers; 2.) End the bailouts; 3.) Get private capital back in our mortgage markets; and 4.) Decrease government exposure to housing?  I believe these four objectives should be the driving forces in our initial decisions regarding GSE reform legislation."

Garrett said, while there are countless ways to address these goals legislatively there are four specific areas that would be good places to start.

First, the combined retained portfolios of Fannie Mae and Freddie Mac (the GSEs) are roughly 1.5 trillion.  While under the conservatorship agreement these portfolios are required to shrink by a small percentage each year to a set level, it should happen faster.  There is a significant amount of interest rate risk in the portfolio and, as the rate environment becomes more volatile it will become increasingly difficult to hedge such a large portfolio against those movements.  There are also significant unrealized gains in the portfolios that should be recognized.

Half of the portfolios are agency MBS, one-quarter is non-agency MBS and the balance includes all types of mortgage loans.  Some of these assets can be sold off more quickly; there is a specific market for each of these assets and each portfolio component should be looked at for the best way to wind it down quickly. Selling assets quickly, Garrett said, may have effect their price but if it happens faster it will reduce taxpayer risk.  He said there were probably a number of people in his audience who would provide a market for some of the assets.

Next, both of the GSEs should be put on the federal government's budget. This transparency will increase budgetary pressure and will force Congress and the Administration to deal with the GSEs "and not let them continue on existing in perpetuity."

"Another area that should be addressed Garrett said, is the Conforming Loan Limit.  To afford a house of almost $730,000, the current limit, a family would need to earn roughly a quarter of a million dollars. "These are the same people that the president wants to raise taxes on.  It doesn't make much sense to raise taxes on those families because they are too 'rich' and then turn around and have the government subsidize them when they want to buy a house!

The fourth area Garrett pointed to as a starting place for change is the Affordable Housing Goals, which he called one of the main causes of the GSE's collapse.  These, he said, should be abolished.

"It is absurd that these two entities, under federal government conservatorship and hemorrhaging billions of taxpayer dollars, have their conservator publishing new affordable housing goals for them to hit. The only goal these two entities should currently have is to reduce their burden on the American taxpayer."

Turning to the future of the housing finance market, Garrett stressed that, whatever shape it takes, securitization will play an integral and vital role. There cannot be a market of over $11 trillion such as in the U.S. without securitization.  There is not enough capital in the banking system without it and currently 75 percent of the market is funded by the secondary market and MBS investors.   "But, while there are a wide variety of positions on the future of housing finance, two things everyone can agree on is that having the federal government continue to underwrite 95% of our nation's mortgage market and having the FHA specifically insure 50% of new originations is completely unsustainable.

Garrett said that he wanted to be very clear that he is firmly committed to a purely private U.S. mortgage market over time - free of government guarantees and subsidies. "I realize that this will not be an easy or immediate goal but it is one I feel strongly about - especially given the role that government involvement in the mortgage market played as a central cause of the financial crisis."

People who support a continued government role raise concerns about a purely private market, Garrett said. But there are just as many concerns with any model that includes government support.  

He refuted "eight of the central claims and assertions made by what some refer to as the 'Housing Industrial Complex." 

1. The 30-year fixed rate mortgage product cannot survive without a government guarantee: "Given the fact that there was a fairly robust 30-year jumbo market before the crash and that you can get a 30-year fixed jumbo today, I don't believe that assertion is correct." Prices would presumably increase and down payments would be higher but Garrett does not feel that is necessarily bad as newer, more consumer friendly products might emerge. Other countries that have higher homeownership rates survive and even thrive without the 30-year fixed and there may be other ways borrowers could access options in the private sector to hedge against interest rate risk. "It appears to me, Garrett said, that this statement is used more to gain political leverage in the debate rather than to truly look at it objectively."
2. The government can easily price the tail or catastrophic credit risk associated with the mortgage market: Garrett citied the Deposit Insurance Fund, National Flood Insurance Program, and the Pension Benefit Guaranty Corporation as three examples that the government cannot effectively price for risk. If politicians are setting the price, he asked, would politics, which is very pro-cyclical, inevitably get involved?
3. The To-Be-Announced (TBA) market must be kept viable and the only way to ensure its existence is to have a government guarantee: The TBA market has provided benefits to consumers by allowing them to lock-in interest rates earlier, he said, it must be remembered that the TBA market is a product of the government guarantee, not the other way around. There are other ways to achieve these benefits such as a more robust interest rate future market or common underwriting standards.
4. There should be a government guarantee because the government always, eventually, steps in if there is a problem: He said he didn't disagree that the government can't help itself from intervening in a number of areas of the free market, but if you set up a specific system and structure to allow the government to step in he expects the chances they will do so will be much greater? Also it may be that a government guarantee leads to more moral hazard.
5. Rates investors are only willing to accept interest rate risk and do not want to take credit risk: We must have rates investors interested in our mortgage market to achieve a significant amount of liquidity but there may be ways to minimize their credit risk through structure or through sound and strict underwriting standards that have performed historically at quantifiable levels regardless of market conditions. Garrett said he has been working on covered bond legislation and that last year U.S. investors bought $22 billion of foreign covered bonds. Eighty percent of these investors were rates buyers so Garrett believes they can be an important component of the broader market if legislation is passed.
6. National Mortgage Servicing Standards should be included in the final version of the Qualified Residential Mortgage (QRM) definition: The argument, Garrett said, is that securitization will not function properly again unless investors feel that the problems in the mortgage servicing area will be addressed. This issue was never mentioned during debates leading to the Dodd-Frank Financial Reform Act. Also, because the QRM definition applies to characteristics which exempt securities from risk retention at origination, "how would a failure in servicing, which is done over the duration of a loan, impact the security that has already been exempted? While the topic is important, it is one that regulators should not unilaterally address without property authority from Congress.
7. Any policy decisions should weigh the impact on affordable housing: "I believe that, if there is to be any government assistance to homeownership, it should be limited to first-time homebuyers or rental housing and that the assistance should be on-budget and appropriated annually by Congress. "Many supporters of affordable housing liked having it funded "off-balance sheet" and many providers of affordable housing funds use it to give them additional political leverage in other areas."
8. The government has to play such a large role in our mortgage market because the private sector refuses to: Garrett asked whether the private sector is avoiding the market because it doesn't want the risk or because it is being priced out by the government's involvement. Other asset-backed markets are functioning without government support. Also, we already have close to $100 trillion of unfunded liabilities, how are we supposed to take on the credit risk of the entire housing market?
   
   

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