Thursday, June 21, 2018

Trump's New Plan for Reorganizing the Government's Role in the Residential Mortgage Market

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Today, the Trump administration released a report entitled Delivering Government Solutions in the 21st Century: Reform Plan and Reorganization RecommendationsThe report is the result of executive order 13781 (titled “Comprehensive Plan for Reorganizing the Executive Branch"), which called for a study on how the executive branch is structured. This report provides the administration's recommendations for a structural realignment of various portions of the executive branch. The report notes that while some changes can be accomplished through executive order, a number of others must come from legislative action.

For the property law folks, I thought you might be interested in what the report says about the administration's plans for Fannie Mae and Freddie Mac, the giants of the secondary mortgage market, and the various mortgage insurance programs (like FHA, VA, etc). Here are some of the more salient portions of the document (underlining provided by me):


This proposal would reorganize the way the Federal Government delivers mortgage assistance and go beyond restructuring Federal agencies and programs by transitioning Fannie Mae and Freddie Mac to fully private entities. Competition to the duopolistic role played by the two privately-owned GSEs would be an essential element of reform to decrease moral hazard and risk to the taxpayer. Both Fannie Mae and Freddie Mac, as well as other competitive entrants, would have access to an explicit Federal guarantee for mortgage-backed securities (MBS) that they issue that is only exposed in limited, exigent circumstances. Such a guarantee would be on-budget and fully paid-for. This would also ensure that the Government’s role is more transparent and accountable to taxpayers, minimize the risk of taxpayer-funded bailouts, and ensure that mortgage credit continues to be available in times of market stress for creditworthy borrowers.


Under the current system, Fannie Mae and Freddie Mac, two privately-owned GSEs, buy and guarantee mortgages from lenders and sell them to investors as MBS. Although they are private companies, they are congressionally chartered, a unique status that has been viewed as conveying an implicit Federal backstop that has in turn lowered their cost of capital relative to similarly-sized institutions. . . In their Federal charters and by action of their primary regulator, the Federal Housing Finance Agency (FHFA), Fannie Mae and Freddie Mac have goals of providing a certain amount of financing to low- and moderate-income borrowers. However, these affordable housing activities are not clearly accounted for on the Federal balance sheet.

In addition to the GSEs, other Federal programs provide mortgage support, contributing to a large Federal footprint in the housing market. The Department of Housing and Urban Development (HUD) Federal Housing Administration (FHA) provides mortgage insurance intended to aid borrowers traditionally underserved by the conventional mortgage market, including lower-wealth households, minorities, and first-time homebuyers. The Departments of Veterans Affairs (VA) and Agriculture (USDA) also administer mortgage insurance programs targeted to veterans and lower-income rural households, respectively. The loans guaranteed by FHA, VA, and USDA are in turn packaged into MBS that are guaranteed by Ginnie Mae, a Federal entity operated by HUD. Together, loans backed by the GSEs and Ginnie Mae comprised about 70 percent of mortgages originated in 2017.

. . . This reorganization proposal, which includes broad policy and legislative reforms beyond restructuring Federal agencies and programs, would:

  • Increase competition. The proposal would remove the Federal charter from statute and fully privatize the GSEs. A Federal entity with secondary mortgage market experience would be charged with regulatory oversight of the fully privatized GSEs, have the authority to approve guarantors, and develop a regulatory environment that is conducive to developing competition amongst new private guarantors and the incumbent GSEs, ensuring they would all be adequately capitalized and competing on a level playing field. If the GSEs lost some of the benefits that have led them to dominate the market, this would enable other private companies to begin competing in this space. The regulator would also ensure fair access to the secondary market for all market participants, including community financial institutions and small lenders. 

  • Increase transparency and accountability. Under this proposal, which would also involve entities outside the Executive Branch of the Federal Government, guarantors would have access to an explicit guarantee on the MBS that they issue that is only exposed in limited, exigent circumstances. Taxpayers would be protected by virtue of the capital requirements imposed on the guarantors, maintenance of responsible loan underwriting standards, and other protections deemed appropriate by their primary regulator. The regulator would set fees to create an insurance fund designed to take effect only after substantial losses are incurred by the private market, including the guarantors, in order to ensure the continued availability of mortgage financing through shifting economic cycles. The projected cost of this guarantee and other fees charged would be on-budget and accountable, resulting in reduced implicit taxpayer exposure.

  • Align incentives and reduce overlap. Under this reform proposal, which would also require legislative and policy changes affecting the mandates of entities that are not part of the United States Government, the GSEs would focus on secondary market liquidity for mortgage loans to qualified borrowers, while HUD would assume primary responsibility for affordable housing objectives by providing support to low- and moderate-income families that cannot be fulfilled through traditional underwriting and other housing assistance grants and subsidies. To effectuate this, the newly fully-privatized GSEs would have mandates focused on defining the appropriate lending markets served in order to level the playing field with the private sector and avoid unnecessary cross-subsidization. A separate fee on the outstanding volume of the MBS issued by guarantors would be used specifically for affordable housing purposes, and would be transferred through congressional appropriations to, and administered by, HUD. 

  • Provide more targeted assistance to those in need. The proposal would be designed so that the affordable housing fees transferred to HUD would enable FHA to provide more targeted subsidies to low- and moderate-income homebuyers while maintaining responsible and sustainable support for homeownership and wealth-building. Some of the fees could potentially be used to support affordable multifamily housing or other HUD activities. All of this support would be on-budget and accountable. 

Part of this is interesting because although Fannie and Freddie would be privatized, they would still be government regulated. Would this "federal entity with secondary mortgage market experience" be the FHFA (the current HUD-related conservator of Fannie and Freddie) or a new agency? It also appears that the goal would be to bring new guarantors (of MBSs) into the marketplace to compete with the GSEs. The report envisions more private entities issuing MBSs, all with some kind of "limited" government guarantee. The taxpayer is going to be protected, so argues the report, by making these guarantors adhere to capital requirements, among other regulations. Of course, the devil is in the details. Banks have capital requirements, but they were swept up into the subprime mortgage crisis. Indeed, they are still playing in the subprime mortgage loan business through their warehouse loan funding of shadow bank lenders like Exeter Finance and others. Does this plan really ensure that "taxpayers would be protected?" The report says that the regulator can impose other appropriate rules, but it's not clear that adding more firms to the secondary marketplace where they all enjoy some form of government guarantee is superior to the existing situation of having merely two. 

With respect to the realignment of incentives, it's not clear to me what "qualified borrowers" constitute in terms of how the adminstration views the role of the new and improved GSEs, versus HUD's "responsibility for affordable housing objectives by providing support to low- and moderate-income families." How will these things be different? In other words, what will animate the "qualifications" for GSE borrowers if not some kind of over-arching demographic target? Will it just be traditional credit-worthiness and risk-driven underwriting?

Lastly, with respect to the idea of providing more "targeted assistance to those in need," I would like to see more details on what those programs would look like. The report says that fees charged on GSE outstanding MBS volumes would be transferred to HUD and that the FHA could use these fees to help subsidize low- and moderate-income homebuyers. But, what does this mean? To help the FHA expand its insurance/guarantee program? Also, does multifamily housing mean an expansion of the existing HUD-backed programs or new programs? This last bullet point feels less development.

As David Reiss has noted on his blog, GSE reform has been brewing in Congress for awhile now (to no avail). We'll see where this goes as well.

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