Calabria and Carson: Housing Leaders Talk Reform, Accomplishments

Attendees at the Ginnie Mae Summit commemorating the agencies 50^th anniversary on Thursday heard from both Dr. Ben Carson, Secretary of the Department of Housing and Urban Development (HUD) and Dr. Mark A. Calabria, newly confirmed director of the Federal Housing Finance Agency (FHFA).  Each addressed their plans for updating their respective housing finance components.

Calabria spoke first to the increasing role of non-bank mortgage originators. In 2013, he said, non-banks originated 30 percent of the mortgages sold to one of the government guarantee programs. By February of this year, that footprint had doubled to 60 percent.  In 2018 those companies originated roughly 50 percent of all mortgages sold to Fannie Mae and Freddie Mac (the GSEs) and they are now Ginnie Mae's main counterparties, servicing around 60 percent of the mortgages in Ginnie Mae pools.

These entities, he said, have brought capacity for both origination and servicing and provide needed liquidity, but there are some key differences between banks and non-banks from a risk perspective and FHFA has been working with the GSEs to improve counterparty risk standards. "Our goal is to ensure that originators have the financial strength to continue lending through any market weakness or stressed environment."

Calabria turned to the need for reform in the mortgage finance system which he said has seen no fundamental change since the financial crisis.  In fact, he said, "the federal government's command of our nation's housing industry has only grown larger over the past decade."  The GSEs' books of business are in better shape than in 2007 and 2008 but they have grown and remain "too big to fail."

Their leverage ratio of nearly a thousand to one makes their capital cushion razor thin and vulnerable to fluctuations in housing prices, interest rates, and other macroeconomic conditions.  It also leaves taxpayers increasingly exposed to another bailout.  In addition, the duopoly of Fannie and Freddie undercuts competition and makes the entire system more fragile.

The status quo, Calabria said, can be very comfortable, and the status quo is a housing finance system essentially the same as in 2008, a system that produced a 26 percent drop in home prices, a more than 80 percent spike in foreclosures, and the evaporation of trillions of dollars in household wealth.  Homeowners remain vulnerable to another shock to the system and taxpayers remain on the hook.

There are two major avenues for reform - administrative action and congressional action and both are needed. "It is not the case that either Congress acts or else I will," he said. "There are some things that only Congress can do. One of them is to create an explicit guarantee," one that is limited, clearly defined, and paid for.

He will also, he said, pursue administrative actions when appropriate and necessary. These will be regulatory actions at FHFA which will involve working with Treasury, HUD, and other regulators.

In a letter accompanying FHFA's 2018 annual report to Congress submitted this week, Calabria said he asked for several legislative reforms. One was authorization for FHFA to issue more GSE charters allowing more competitors to enter the industry.

Reform, he said, should not have to wait for the next crisis; it is about preparing ourselves to withstand it. The economy and housing market are strong today, but booms are eventually followed by busts and the housing finance system has long fueled these cycles. "It has pushed the peaks higher and dragged the valleys lower than they might otherwise be." What is needed instead is a counter-cyclical housing finance system.

The administration has directed the Treasury and HUD Secretaries to develop a housing reform plan on which Calabria said he is consulting. The objective is to give taxpayers confidence that the country's mortgage giants will never need another bailout and assure investors of the strength and resiliency of the secondary mortgage market.

Part of the strategy is to end the Fannie and Freddie conservatorships which have lasted far longer than anyone expected. The decade long condition is at odds with what is contemplated in the statute. The foundation to ending conservatorship is capital and Calabria says his primary concern is that Fannie and Freddie maintain capital levels commensurate with their risk profiles. Over time they should operate under essentially the same capital rules as other large financial institutions.

It is necessary to address the Net Worth Sweep, but it would likely take a very long time to build sufficient capital through retained earnings alone.  It is necessary to investigate other avenues to raise capital, perhaps a public offering of some kind. It is early in the process and much work and analysis remain to explore all options. However, Calabria estimates that by next year the GSEs will be on a path to rebuild capital.

Calabria also laid out an agenda for pursuing regulatory reforms that will prepare FHFA to transition into a post-conservatorship role. While maintaining those rules established under the previous directorship that make sense, work will continue on rules to establish sound, prudent standards for both the amount and the quality of capital. FHFA is also reviewing all recent expansions into new markets and activities "to put an end to the era of charter creep. Anything that falls outside the GSEs' core business model and mission will be curtailed or ended altogether."

"We are also looking at every rule and regulation to ensure that we are creating a level playing field across the industry," he said. One of his responsibilities is to create a competitive mortgage market. "To do that, everyone must operate under the same rules."

He concluded his speech by stating that when reforms are implemented, the GSEs will be able to build a sound capital base, backstopped by world-class supervision and regulation. This should bring added confidence to all market participants. 

Carson noted the growth of Ginnie Mae's mortgage-backed securities (MBS) portfolio in the last decade, from less than $500 billion in 2008, it has grown by approximately 420 percent. At the same time, he said, it has earned the trust of investors around the world.

Still, HUD has an ambitious agenda for reforming the agency which securitizes mortgages guaranteed by FHA, the VA, and USDA. The reforms target broad modernization upgrades to the MBS program and platform, and enhancements to managing counterparty credit risk.

Carson praised earlier steps in the modernization program which arose after the housing crisis and said the agency's "state-of-the-art" technology platform, provides a secure, flexible and scalable way to support major business applications, improve user experience, transform business processes, advance access to data, and otherwise adapt to fast-moving dynamics in the housing market.  There have also been two new offerings introduced to Ginnie's Platinum line of products in the past year.

Still, modernization remains a priority as does obtaining better housing outcomes. "Housing models are better able to sustain capital markets - and serve the American people - through elevating data above doctrine or guesswork."

A key initiative is the creation of a digital mortgage ecosystem - one that encompasses everything from loan applications through securitization - while reducing the risk from defects in loan instruments. This will require Ginnie Mae to implement and develop the capabilities necessary to take in digital promissory notes and loan files as acceptable collateral for securities.

This summer, Ginnie will publish and solicit stakeholder feedback on a draft policy guidance describing requirements for an issuer to participate in the upcoming digital mortgage pilot. Once the pilot, which has been informed by stakeholder feedback, has achieved lift-off, it will be upscaled over time while additional system and MBS program enhancements are added.

Ginnie will also develop a new document custody application as well as new loan delivery and pooling applications with the goal of moving from pool-level securitization model to a loan-level program.

Carson likened the current pool-level orientation to buying 10 flavors of ice cream and mixing them together. "That may work okay for two or three flavors, but once you get up to a high enough number, you can no longer disentangle all the important differences between the flavors."  In Ginnie's situation, the same institution must always be the servicer of record for all the loans first combined in a single pool. The servicing rights (MSR) may be transferred, but the loans in the pool can't be disentangled, and the owners of the MSR can't manage their assets efficiently.

This creates a ripple effect on the MSRs' desirability and value, while neither GSE has to deal with the same constraint. This creates a higher cost for government loans when compared to conventional loans.

Moving to loan level capability and aligning servicing capabilities with loan characteristics could pay many dividends to Ginnie and to investors. It could also attract new institutions that have been hesitant to invest in government mortgage servicing rights under the existing model.

Carson called efforts to enhance the agency's management of counterparty risk "critical." In the past, risk management has meant monitoring compliance with a one-size-fits-all set of program standards. But given Ginnie's expanded role in mortgage finance and the increasing breadth and sophistication of its products, certain risks have been heightened.  He said there are four questions Ginnie must always be prepared to answer to show it is ready for risk management.

1. "Was Ginnie Mae prepared for times of stress?"
2. "Did Ginnie Mae take the right steps to ensure issuers of all sizes and types were capable of operating through the cycle?"
3. "Did our security continue to be attractive to investors around the globe to secure capital into America's housing finance system?"
4. And most importantly, "Were the borrowers who the federal housing programs are intended to serve able to maintain access to affordable mortgage financing without major disruption?"

Ginnie has published two All Participants Memoranda on counterparty risk in the past year and another with additional counterparty risk standards will be published in July.  These memoranda improve the treatment of counterparty risk without unduly affecting credit availability.  There are also plans to put certain protective requirements in place for those issuers who present the greatest risk in the event of a default or extinguishment of their portfolio size.

Ginnie is also reviewing three closely related areas that need more development to protect the mortgage finance industry with an adequate prudential regulation. When finished, policies will be implemented for each.

1. What is the right level of capital and liquidity a non-bank issuer should hold?
2. What needs to be in place to evaluate the ability to withstand times of stress?
3. What standards should be developed to improve recovery and resolution planning?

Carson concluded, "As we move forward, we will determine how broadly new policies should apply. Our review in this space also presents an opportunity to increase engagement with other federal partners and state regulators and coordinate our efforts."