FHFA Sends Congress Strategic Plan for GSEs

The Federal Housing Finance Agency
(FHFA) said Tuesday that, with its conservatorship of Fannie Mae and Freddie
Mac (the Enterprises) now in operation for more than three years “and no
near-term resolution in sight,” it was time to assess its goals and
directions.  In a letter submitted to the
chairs
and ranking members of the House Committee on Financial Services and the
Senate Committee on Banking, Housing, and Urban Affairs, Acting FHFA Director
Edward J. DeMarco set out a Strategic Plan
for Fannie Mae and Freddie Mac Conservatorships
with three goals:

  1. Build a new infrastructure for the secondary mortgage
    market;
  2. Gradually
    contract the Enterprises’ dominant presence in the marketplace while
    simplifying and shrinking their operations;
  3. Maintain
    foreclosure prevention activities and credit availability for new and
    refinanced mortgages.

DeMarco said in moving forward FHFA has
to consider that:

  • The
    Enterprises’ losses are of such magnitude that they will not be able to repay
    taxpayers in any foreseeable scenario;
  • The
    operational infrastructures of each are working but require substantial
    investment to support future business which presents an issue of whether to
    rebuild or start anew;
  • Minimizing
    taxpayer losses, ensuring market liquidity and stability requires preserving
    the Enterprises as working entities but this requires some things such as
    retaining private sector pay comparability that have generated concern because
    of taxpayer involvement;
  • Although
    the housing finance system cannot be called healthy it is stable and
    functioning, albeit with substantial government support;
  • Congress
    and the Administration have not reached consensus on how to resolve the
    conservators and define a path forward.

The absence of any existing meaningful
secondary mortgage market mechanisms beyond the Enterprises and Ginnie Mae is a
dilemma for policymakers who want to replace them and was a key motivation for
conservatorship in the first place.  The
elements for rebuilding the system are already known and work can begin without
knowing whether there will be a government guarantee other than through FHA.  A secondary market structure without the
Enterprises would likely include:

  • A
    framework to connect capital markets to investors to homeowners – i.e. a
    securitization platform that bundles mortgages and provides support to process
    and track payments from borrowers through to investors.
  • A
    standardized pooling and servicing agreement that corrects the many shortcomings
    in the agreements used in the private-label mortgage-backed securities (MBS)
    market pre-housing crisis.
  • Transparent
    servicing requirements that set forth servicers responsibilities to investors
    and borrowers.
  • A
    servicing compensation structure that promotes competition rather than concentration
    of servicing, takes into account servicers’ costs and requirements, and
    considers the appropriate interaction between origination and servicing
    revenue;
  • Detailed,
    timely and reliable loan-level data for investors that is maintained through the
    life of the MBS.
  • A
    sound, efficient system for document custody and electronic registration that
    respects local property laws and enhances the liquidity of mortgages.
  • An
    open architecture for all these elements to facilitate entry to and exit from
    the marketplace and an ability to adapt to emerging technologies and legal
    requirements over time.

Since entering conservatorship the
Enterprises have guaranteed roughly 75 percent of the mortgages originated in
the U.S. with FHA guaranteeing most of the rest.  Shifting mortgage credit risk away from the
Enterprises to private investors could be accomplished in several ways.  The following are either under consideration
or actively being implemented.

  • Increase
    guarantee fee pricing. In September,
    2011 FHFA announced its intention to continue a path of gradual prices
    increases based on risk and the cost of capital. In December Congress directed it to increase
    guarantee fees by at least 10 basis points as part of the revenue raising
    aspects of the Temporary Payroll Tax Cut Continuation Act and Congress also
    encouraged FHFA to require guarantee fee changes that reduce
    cross-subsidization of relatively risky loans and eliminate differences in fees
    across lenders not clearly based on cost or risk.
  • Various
    approaches, including senior-subordinated security structures that could result
    in private investors bearing some or all of the credit risk.
  • Expand
    reliance on mortgage insurance through deeper mortgage insurance coverage on
    individual loans or through pool-level insurance policies that would insure a
    portion of the credit risk currently retained by the Enterprises.

The
Enterprises do not dominate the multi-family credit guarantee business and
approach it very differently from their single-family business.  For a significant portion, Fannie Mae shares
risk with loan originations and for a significant and growing part Freddie Mac
shares credit risk with investors through securities.  Given these conditions, generating potential
value for taxpayers and contracting the multifamily market footprint should be
approached differently and each Enterprise will undertake a market analysis of
its operations.

Capital
market activities have long been considered the Enterprises’ source of greatest
profits, controversy, and risk.  These
have been used to fund the retained portfolios and is a complex business
activity requiring specialized and expert risk managers.  This business line is already on a gradual
wind-down path with the Treasuring requiring a 10 percent reduction in the retained
portfolio each year.  New mortgages are
primarily delinquent ones removed from MBS and other legacy assets have little liquidity.  Over time the retained portfolios are
becoming smaller but also less liquid. 

Maximizing
taxpayer value on these assets is a key consideration and there is argument for
holding some for a longer period.  This
in turn requires management, either by retaining in-house expertise or by contracting
to a third party.  The first is less disruptive
but requires human capital risk which increases with the proposed legislation
on Enterprise compensation.  The second
would hasten the shrinkage in Enterprise personnel but would be more costly and
would pose new control and oversight issues for FHFA.

The
third strategic goal is maintaining foreclosure prevention efforts and credit
availability
.  The Enterprises must
continue and enhance:

  • Successful
    implementation of the Home Affordable Refinance Program (HARP) along with the
    program changes announced last October.
  • Continued
    implementation of the Servicing Alignment Initiative including its approach to
    loss mitigation through loan modifications and early outreach to distressed
    borrowers;
  • Renewed
    focus on short sales, deeds-in-lieu, and deeds-for-lease options;
  • Further
    development and implementation of the REO disposition initiatives announced by
    FHFA last year including efforts to convert properties into rental units.

The Enterprises almost need to resolve other
long-standing concerns in the marketplace that may be suppressing a more robust
recovery and limited credit.  One major
issue is concerns over representations and warrantees.  These policies must be made more transparent
and conditions for their implementation defined.

In accomplishing the three goals, there
must be consideration of human capital as well. 
The boards and executives responsible for the business decisions that
led to conservatorship are long gone and shareholders of the Enterprises have
effectively lost their investments. The public interest is best served by
ensuring that the Enterprises have the best possible leaders to carry out the
work and a search is underway for new CEOs for each company and other
executives willing to take on the necessary challenges in the face of ongoing
criticism of the companies and uncertain legislative environment.  FHFA and the Enterprise boards have taken
seriously the Congressional criticism of compensation structure and are working
to create new ones that will be all salary with the largest portion deferred
and at-risk.

…(read more)

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