What Role Will the Government Play in a Reformed Housing Market?

Edward J. DeMarco, Acting Director of the Federal Housing Finance Agency, told members of SIFMA this afternoon that "The secondary mortgage market infrastructure that served this country for many years is broken."  It is not effective when it comes to adapting to market changes, issuing securities that attract private capital, aggregating data, or lowering barriers to market entry he said.  There must be some updating and continued maintenance of the government sponsored enterprises securitization infrastructure, "and to the extent possible, we should invest taxpayers' dollars to this end once, not twice."

He told SIFMA members that, as those who invest in the secondary market, they are uniquely positioned to contribute to policy discussions about the future of the housing finance system. There are many views and many important issues about access to credit and fair treatment for borrowers, and fostering a competitive primary and secondary mortgage market. But if we really are serious about expanding the private sector's role in housing finance, we must consider what types of changes are necessary to bring private capital back to the housing finance market.

The conservatorships of Fannie Mae and Freddie Mac were never intended to be long-term solutions.  They were meant as a "time-out" as the market was eroding and a way to provide some stability while decisions were made about rebuilding the housing finance system.  Today the government is involved in nine out of every ten mortgages so it is essential that the mortgage market transition to a more secure, sustainable, and competitive market.

DeMarco said that the country's regulatory infrastructure sets and enforces certain rules of the road; in part to ensure that fraud or poor business decisions don't create spillover costs for the system but also to add certainty and transparency; protect customers and promote access to credit.  But the owners of private capital must make informed decisions about the allocation of resources to promote economic growth and prosperity.

"In the mortgage market, that means we need established rules by which everyone abides. But we also need competitive markets and market participants operating within those rules to ensure that credit is available to help families purchase homes and rent houses and apartments.  A competitive private market system also ensures that such capital is efficiently allocated between housing and all other sectors."

Regardless of how the conservatorships are resolved, the Acting Director said, we know the nation will need a healthy and efficient secondary market and FHFA has set out to develop a framework that will serve the GSEs in the short term and have broad application in the future. 

FHFA recently issued a white paper in which the development of a new infrastructure was divided into two components; the "physical" infrastructure or platform which comprises the technology that drives the existing secondary market operations and the "virtual" infrastructure, meaning the contractual provisions that govern secondary market transactions.

The Enterprises' outmoded proprietary infrastructures need to be updated and maintained, DeMarco said, and any such update should provide enhanced value to the mortgage market with a common and more efficient model.  FHFA has undertaken this effort with the goal that it will have benefits beyond the GSE business model. Therefore, this new infrastructure must be operable across many platforms, so that it can be used by any issuer, servicer, agent, or other party that decides to participate.

In the white paper FHFA raised the issue of the platform's scope.  The focus could be on functions that are routinely repeated across the secondary mortgage market, such as issuing securities, providing disclosures, paying investors, and disseminating data.  Each is a function where standardization could have clear benefits to market participants.  For example, if there is to be some type of federal guarantor of mortgage-backed securities, that guarantor will need these functions performed.  Private-label mortgage-backed securities market might also benefit from such a utility. Providing standardization across key mortgage market functions should add depth and liquidity to the market.

The second component of the securitization infrastructure - the contractual framework - is governed in the current securitization model by the GSEs' Selling and Servicing Guides. These set forth the rules that sellers must follow to obtain the GSE guarantee and the rules for servicing mortgages, including the procedures that must be followed to address delinquent loan servicing.

The equivalent in the private-label securitization market is the Pooling and Servicing Agreement or PSA, a legal document that lays out the responsibilities and rights of the servicer, the trustee, and others over a pool of mortgage loans.  While the PSA covers some of the same issues as the Guides, there has been more variation in the individual agreements.  Variation in terms can lead to tailoring of transactions to meet particular investor requirements, but greater standardization in some areas could add more liquidity and more certainty to the market.  In addition, as became evident during the financial crisis, the responsibilities of various parties in the PSA agreements may have made resolution of issues more difficult and added to the losses of many investors.

While the GSE's are working toward harmonizing requirements in their respective Seller and Servicing Guides, this is an optimal time to further consider how best to address contractual shortcomings identified during the past few years.

Some of the work already underway which will fit into the various parts of a new infrastructure for housing finance are:

• The Uniform Mortgage Data Program is improving the consistency, quality and uniformity of data gathered at origination and for servicing. Common data definitions, electronic data capture, and standardized data protocols will improve efficiency, lower costs, and enhance risk monitoring.
• Settling on servicing standards will provide clarity on how troubled loans will be serviced and FHFA's Servicing Alignment Initiation produced a single set of protocols for both GSEs which may serve as a basis for national servicing standards.
• FHFA's Joint Servicing Compensation Initiation is considering alternatives for future mortgage servicing compensation.
• The Representation and Warranties framework long used by the GSEs did not work well under stress conditions so the GSEs have developed a new framework that will clarify lenders repurchase exposure and liability on deliveries after January 1.
• The Loan-Level Disclosures announced last year will help establish consistency and quality of data for investors in Enterprise MBS.

DeMarco said that there is no simple path to rebuilding the country's housing finance system and there are still many fundamental questions about the end state of housing finance reform.  There are also difficult transition issues to consider and FHFA is working to help pave that transition to whatever end state policymakers ultimately choose.

One step is to contract the GSE operations.  To that end, FHFA is increasing guarantee fees and pursuing initiatives with the potential to transfer some credit risk to the private sector, a goal that most policymakers seem to agree with. While FHFA will continue to work in this area, if policymakers are serious about limiting the government's role, more direct action may be needed to have significant near-term effects.

The most fundamental question in considering the end game for housing finance reform is what, and how big, should the role of the federal government be?  This, DeMarco said, is clearly where there are diverging policy and political views, but stakeholders must start to think through this process.  Perhaps it will be easier to break this question up into component parts, not to suggest a particular legislative strategy, but rather a defined ordering of how to think about housing finance reform. 

One potential place to start is what the role of the traditional government mortgage guarantee programs, like the Federal Housing Administration or FHA, should be.  If FHA's role in the future is defined in terms of which borrowers would have access to this program, then it should be easier to look at the rest of the market and consider questions like:

• "What is the capability and capacity of private market participants to intermediate credit for single-family housing? What functions are necessary to have an efficient market?"
• "How should standards be established and updated in the market to enhance efficiency, risk assessments, and liquidity, thereby lowering costs to borrowers and investors alike?"
• "Where do we think the market system requires prudential government oversight or limits? Have we ensured that any oversight or limits act to foster, not inhibit, competition, including fostering the full participation of small and mid-sized firms in the mortgage market?"
• "Are there remaining public policy concerns about potential market failures and, if so, are those concerns about market stability and liquidity or about social policy goals regarding homeownership?"