DeMarco Announces Six Month Notice for Loan Limit Changes

While not directly acknowledging the protests that have come from both the public and private sectors about his decision to unilaterally lower loan limits, Edward J. DeMarco, acting director of the Federal Housing Finance Agency (FHFA) backed off a bit in a speech on Thursday.   DeMarco announced last summer that limits on the size of loans eligible for purchase or guarantee by Freddie Mac and Fannie Mae (the GSEs) would be reduced from their current limits.    

FHFA and its predecessors traditionally announce new, almost always higher, loan limits in November, to be implemented at the first of the following year. The current limit of $417,000, has been renewed each year since the beginning of the financial crisis however the ceiling on county-by-county exceptions for high value areas was lowered in 2012 to $625,500.

DeMarco, in a speech before Zillow and the Bipartisan Policy Center said he understands the potential timing issues associated with a change in limits given the other regulatory changes taking place at the same time.  Therefore, while FHFA will follow the usual November timetable in announcing 2014 conforming loan limits, it would provide six months' notice before implementing the change.  Any reduction would be across the board, he said, not just in some parts of the country.   The agency will also provide further information in November on potential reductions in the size of loans the GSEs will guarantee going forward.

The timing change had been rumored earlier this month after DeMarco was strongly criticized by many industry groups, including the National Associations of Realtors and Home Builders for the decision and the legal basis of his authority questioned.  Thirteen members of the Senate also sent a letter earlier this month challenging him to demonstrate his authority to raise the limits and provide an analysis of the impact of such action.  

DeMarco said that while ideas about timing and methods vary, there is a general desire among stakeholders to reduce government's footprint in mortgage financing and encourage private capital to reenter the market.  Lowering loan limits is just one of the tools FHFA has to accomplish this objective, he said.

A second method is to increase GSE guarantee fees which currently average 50 basis points, about double what they were prior to conservatorship.  Increasing these fees brings their pricing for credit risk closer to what would be required by private sector providers. "While that level is difficult to evaluate with precision," DeMarco said, "I believe we are getting closer to a level that would encourage more private sector participation."  Any additional changes going forward would be measured and gradual so as not to disrupt markets.

The third tool is risk sharing which is important for reducing the taxpayers' long term risk exposure.  The Acting Director said one of FHFA's 2013 Scorecard targets is for each of the GSEs to achieve $30 billion in risk-sharing transactions and both Freddie Mac and Fannie Mae have recently completed securities-based transactions and Fannie Mae laid off substantial risk to a private mortgage insurer.

Going forward, he said, he expects to see other types of transactions such as senior/subordinated structures for certain portions of the Enterprises' mortgage guarantees.  These alternative approaches will contribute to efforts to build for the future by helping to develop a securitization infrastructure that is less reliant on the Enterprises' traditional GSE securitization model.

DeMarco said it is clear the GSEs, which had a failed business model, will cease to operate in their current form at some future date  and FHFA's strategic plan is designed to prepare the companies and the market for that date, while maintaining stability and liquidity from now to then. The agency will soon establish multi-year targets for the GSEs to contract the footprint, maintain liquidity and borrower assistance, and build for the future.

FHFA expects certain assets, functions, and employees at the two companies will be repositioned in the private sector by the end of the conservatorships.  In the meantime, each company will need to enhance their core operations that are expected to operate in the marketplace and to gradually sell or wind down certain operations not expected to go forward.

The GSEs' retained portfolios have been steadily declining since 2009 and their composition has changed significantly.  Prior to conservatorship they were dominated by the GSEs' own mortgage-backed securities and performing whole loans.  As those securities have been paid down, and as the need to work through delinquent loans increased, the retained portfolios changed from being relatively liquid to being less liquid.

The 2013 goal of selling 5 percent of the less liquid portion of the portfolios, i.e. the retained portfolios excluding agency securities has been executed well.  Going forward, given that FHFA is not repositioning the retained portfolio business of the GSEs it will look for additional ways to shrink this business line over an appropriate time horizon.

The market appears to have absorbed the GSEs goal of contracting their multifamily involvement market by 10 percent in 2013 without major disruption.  Without a legislative path informing the repositioning of this market FHFA will continue to take gradual steps to reduce multifamily exposure while maintaining a market presence.

DeMarco praised the work of the Bipartisan Policy Center in providing a framework for legislation.  A key feature required 10 percent private sector exposure in front of any guarantee and this was picked up in early efforts in the Senate.  "If there is  going to be a government guarantee of this type," he said, "it must have sufficient private capital standing in front of that guarantee, or we will be to some degree re-creating the failed GSE business model."   The PATH Act proposed in the House has proposed a different course based on developing standards and infrastructure to bring liquidity and efficiency to the mortgage market, as opposed to establishing a new government guarantee.  Both bills, he said, are worthy of serious consideration.