The Senate Banking Committee held a hearing on September 10 on the Trump administration's housing finance reform plans. US Department of Treasury Secretary Steven Mnuchin, US Housing and Urban Development Secretary Ben Carson and Federal Housing Finance Agency Director Mark Calabria testified.
Treasury's Housing Reform Plan and HUD's Housing Finance Reform Plan, released on September 5 and produced in response to a presidential memo dated March 27, 2019, are both designed to reduce the federal government's footprint in housing finance, increase the role of the private sector and private capital in the market and, eventually, end the GSE (government-sponsored enterprise) conservatorships and return Fannie Mae and Freddie Mac to private shareholder ownership. The plans contemplate enhanced lending standards for the GSEs and an explicit federal guarantee backstopping those mortgages that the GSEs will support.
To that end, and to the delight of many hedge funds that have invested in the stock of Fannie Mae and Freddie Mac, Secretary Mnuchin yesterday morning told Fox Business that, as a step toward returning the GSEs to private ownership, Treasury soon expects an agreement with the FHFA that will allow Fannie Mae and Freddie Mac to begin retaining their earnings by modifying or ending the so-called "net worth sweep" agreements under which Fannie Mae and Freddie Mac each quarter currently transfer their net profits to the federal government.
Secretary Mnuchin says this would allow Fannie and Freddie to rebuild their capital, thereby improving their safety and soundness against future losses and that it would also eventually attract third-party capital, indispensable preconditions to returning them to the private sector while also protecting taxpayers. While Secretary Mnuchin would not commit to cancelling the scheduled September net profit sweeps for Fannie and Freddie, he did indicate that a change in the net worth sweep agreements would come very soon after September if not by then.
Both plans include a number of legislative proposals as there are many steps toward achieving housing finance and GSE reform that could only be taken if the Congress passed, and the President signed, a law. However, the Trump administration has made it clear that it intends to proceed with various housing finance reforms it believes can be achieved through administrative action, whether or not any legislation is enacted.
This approach would certainly seem necessary for any type of housing finance reform to move forward at this time. Simply put, with Republican control of the Senate and Democratic control of the House of Representatives, a presidential election year rapidly approaching, and many other issues higher up on Congress's legislative agenda than these issues, the prospects for the enactment of any meaningful housing reform legislation in this Congress are very slim.
Given such bleak legislative prospects, the question that remains to be answered is just how far the Trump White House is prepared to push the envelope in seeking to proceed with housing finance reform through administrative action.
Predictably, the opening statements of Banking Committee Chairman Mike Crapo (R-ID) and Ranking Member Sherrod Brown (D-OH) identified very sharp partisan differences between the two senators. Chairman Crapo's focus was on the need to end the GSE conservatorships after more than 11 years and $191 billion in federal support by rebuilding the capital of the GSEs while protecting the taxpayers from further bailouts. Chairman Crapo emphasized that Fannie and Freddie were systemically important, extremely highly leveraged institutions that currently are "too big to fail" and that the GSE conservatorships were not intended to be permanent.
In contrast Ranking Member Brown, in his opening statement and his questions to the witnesses, characterized the administration's proposal as just another gift to Wall Street that would reduce, if not eliminate, the availability and affordability of the 30-year fixed-rate mortgage, adversely impact minority home ownership, and make housing less affordable generally. Senator Brown says the plan will make mortgages more expensive and harder to get. He also argues that it will not be possible for the GSEs to raise the kind of money from an IPO that the administration's plan contemplates at the same time that the GSEs' "footprint" would be shrinking. While all parties to the debate emphasize the importance of preserving the 30-year fixed-rate mortgage, they dispute whether the White House plan will in fact achieve this outcome.
Senator Pat Toomey (R-PA) said that the affordability problems in the housing market stemmed from an inadequate supply of housing stock as a result of overbearing state and local regulation, not because of problems in housing finance itself. Senator Toomey also argued that housing subsidies should target low-income borrowers not the high-risk credit transactions supported by the current system.
Senator Robert Menendez (D-NJ) got Secretary Mnuchin to confirm that legislation would be required to change the conforming loan limits in high-cost areas and that this could not be accomplished administratively. Senator Menendez also questioned whether the private sector could take up the slack in multi-family housing that would result if the federal government's role in multi-family housing was reduced as Treasury's plan contemplates.
Senator Tom Cotton (R-AR) returned to Senator Toomey's argument as to the adverse impact of local and state regulations restricting the availability of housing stock. Both Secretary Carson and Director Calabria agreed with the proposition that state and local restrictions were adversely affecting housing availability.
Senator Jon Tester (D-MT) questioned Secretary Mnuchin about the impact of a national plan on the availability of housing finance in rural areas. Senator Tester questioned the administration's apparent assertion that a 30-year fixed-rate mortgage could exist without government support. After being pressed, Secretary Mnuchin conceded that government support would be required for most 30-year fixed-rate mortgages to continue to be widely available.
Senator Mike Rounds (R-SD) emphasized that Chairman Crapo and former Chairman Tim Johnson (D-SD) already demonstrated that a legislative solution to housing finance reform was achievable.
Senator Mark Warner (D-VA) expressed concern that the proposed administrative changes reducing the GSEs' footprint would result in less cross-subsidy, thereby resulting in less available affordable mortgage financing. Senator Warner also argued that the administrative changes are just a form of "recap and release" that doesn't eliminate the "too big to fail" problem. He asked whether the GSEs would receive SIFI (systemically important financial institution) designation and whether the FHFA would continue to support the affordable housing trust fund. Director Calabria said that he would continue to fund the affordable housing trust as required by the statute, but neither Director Calabria nor Secretary Mnuchin would opine on the question of whether the GSEs would be designated as SIFIs.
Senator John Kennedy (R-LA) pressed Director Calabria to address the leverage problems at the GSEs through administrative action to change their lending standards as 19 cents coverage for every $100 of mortgage loans simply is not sustainable.
Senator Doug Jones (D-AL) told Secretary Carson that the administration's reforms would make housing less available and less affordable. Senator Jones pressed Secretary Carson on what he considers a lack of commitment by the administration to address housing discrimination.
Senator Jerry Moran (R-KS) argued that increasing competition among guarantors by creating alternatives to Fannie and Freddie would result in better outcomes for borrowers and taxpayers. Secretary Mnuchin stated that the capitalization of the GSEs is worse today than before the 2008 financial crisis and that the GSEs could not operate today were it not for the federal government's financial support.
Senator Tina Smith (D-MN) asked whether a utility type model that regulates the GSEs' rate of return could work. Secretary Mnuchin and Director Calabria both expressed support for allowing the FHFA to regulate the GSE's pricing and rate of return on mortgage products.
Senator Martha McSally (R-AZ) questioned Director Calabria about the 1000 to 1 leverage ratio for Fannie Mae and the implications of having so little capital, given the risk of another downturn in the economy, including another housing crisis.
Senator Jack Reed (D-RI) pressed Director Calabria to commit to fund the Capital Magnet Fund and the Affordable Housing Trust Fund. Director Calabria said that he would do so in accordance with the limits of the law. He added that he was an independent regulator and that the FHFA had not yet done an analysis of the impact of the administration's plan. Secretary Mnuchin said that Treasury had not yet done an analysis of the impact of the administration's plan on housing affordability. Director Calabria said that competition among guarantors should reduce prices and provide better outcomes. When Senator Reed asked about the $300 billion in dividends paid to the Treasury by the GSEs, Secretary Mnuchin replied that he expected the taxpayers to continue to be compensated for the risk of providing governmental support to the GSEs.
Senator Catherine Cortez Masto (D-NV) disputed the assertion that state and local overregulation was the reason for a lack of housing stock. The Senator asked Secretary Carson whether he supported the affordable housing trust fund. The Secretary said that he would like to have some more flexibility in the affordable housing trust fund, but he did not specify what that meant.
Senator Chris Van Hollen (D-MD) followed up with Secretary Carson regarding Senator Jones' question about housing discrimination and the disparate impact issue. Senator Van Hollen said that HUD's position on housing discrimination and the disparate-impact issue is inconsistent and goes way beyond what the Supreme Court's decision on disparate impact requires.
Ranking Member Brown made some closing comments and expressed interest in working with Secretary Mnuchin and Director Calabria on a "utility" type model for the GSEs with a regulated rate of return.
Chairman Crapo then announced that senators would have one week to submit supplemental questions for the record and the hearing concluded.
The Treasury and HUD housing finance reform plans
Below is an overview of the Treasury's Housing Reform Plan:
Among the administrative changes proposed:
- Pending legislation, each GSE should be recapitalized so that private capital takes the first-loss position on the GSE's exposure to risk and loss.
- Pending legislation, each PSPA (preferred stock purchase agreement) should be amended to compensate the federal government for the continued support of the GSEs through an appropriately priced periodic commitment fee.
- Pending legislation, the FHFA should assess whether each of the current products, services and other single-family activities of each GSE is consistent with its statutory mission and should continue to benefit from support under Treasury's PSPA commitment (with appropriate amendments to the PSPA) and, in particular, the FHFA should solicit information on whether to tailor support for cash-out refinancings, investor loans, vacation home loans, higher principal balance loans and/or other subsets of GSE-acquired mortgage loans.
- Pending legislation, Treasury and the FHFA should consider amending each PSPA to limit support of each GSE's multifamily business to its underlying affordability mission, including potentially through a revised framework for capping each GSE's multifamily footprint.
- The FHFA should revisit the GSEs' underwriting criteria for acquisitions of multifamily loans secured by properties in jurisdictions that adopt rent-control laws or other undue impediments to housing development.
- Pending legislation, the FHFA should exercise its authority as conservator to begin the process to end each GSE's conservatorship in a manner consistent with the preconditions set forth in this plan. Treasury and the FHFA should develop a recapitalization plan for each GSE after identifying and assessing the full range of strategic options.
- Pending that recapitalization plan, and as an interim step toward the eventual PSPA amendment contemplated by this plan, Treasury and the FHFA should consider permitting each GSE to retain earnings in excess of the $3 billion capital reserve currently permitted, with appropriate compensation to Treasury for any deferred or foregone dividends.
- The FHFA's eventual regulatory capital requirements should require that each guarantor, or each GSE pending legislation, be appropriately capitalized by maintaining capital sufficient to remain viable as a going concern after a severe economic downturn and also to ensure that shareholders and unsecured creditors, rather than taxpayers, bear losses.
- The FHFA's eventual regulatory capital requirements also should include a simple, transparent leverage restriction that supplements the risk-based capital requirements. The FHFA should, in prescribing regulatory capital requirements, provide for appropriate capital relief to the extent that a guarantor, or a GSE pending legislation, transfers mortgage credit risk through a diverse mix of approved forms of CRT (credit risk transfer).
- The FHFA should prescribe liquidity requirements that require each guarantor , or each GSE pending legislation, to maintain high-quality liquid assets sufficient to ensure it operates in a safe and sound manner.
- Pending legislation, Treasury and the FHFA should amend each PSPA to further reduce the cap on the GSE's investments in mortgage-related assets, setting a different cap for each GSE, and also to restrict the GSE's retained mortgage portfolio to solely supporting its business of securitizing MBS (mortgage-backed securities).
- The FHFA should, in consultation with the other federal financial regulators, endeavor to harmonize the regulatory requirements applicable to the GSEs and other participants in the housing finance system, including with respect to the capital relief provided to GSEs and banking organizations for their transfers of mortgage credit risk to third parties.
- Following any change to the CFPB's (Consumer Financial Protection Bureau's) ability-to-repay rule, the FHFA should revisit the determination as to which single-family mortgage loans should be eligible for acquisition by the GSEs (with appropriate amendments to the PSPAs) or, following legislation, be eligible to secure government-guaranteed MBS.
- Pending legislation, Treasury and the FHFA should amend each PSPA to require each GSE to maintain a nationwide cash window for small lenders and to prohibit volume-based pricing discounts or other similar incentives.
- Pending legislation, the FHFA should revisit its rule excluding captive insurance companies from FHLBank membership in light of the continued evolution of the housing finance system.
While the prospects for legislative changes in this Congress are remote at best, among the legislative recommendations are the following key priorities:
- Congress should authorize an explicit, paid-for guarantee by Ginnie Mae of qualifying MBS that are collateralized by eligible conventional mortgage loans.
- Congress should authorize an explicit, paid-for guarantee by Ginnie Mae of qualifying MBS that are collateralized by eligible multifamily mortgage loans.
- Congress should condition the availability of the government guarantee of qualifying MBS on a GSE or other FHFA-approved guarantor taking the first-loss position on the Government-guaranteed MBS through specified credit enhancement on the mortgage collateral securing the MBS.
- Congress should authorize the FHFA to set and from time to time adjust fees for Government guarantees of qualifying MBS so that the compensation paid to the federal government is, to the extent it might be feasible, consistent with the pricing of similar risk by private sector market participants (accounting for government support in other market segments).
- Congress should restrict the permissible activities of guarantors to the business of securitizing government-guaranteed MBS.
- Congress should implement a framework to limit the aggregate footprint of multifamily guarantors.
- Congress should limit the multifamily mortgage loans that are eligible to secure government-guaranteed multifamily MBS to ensure a close nexus to a specified affordability mission.
- Congress should repeal the existing statutory definitions relating to the GSEs' regulatory capital that restrict the FHFA's discretion in prescribing regulatory capital requirements, and those definitions should not be incorporated into future legislation.
- Congress should authorize the FHFA to require each large guarantor, or a holding company of the large guarantor, to maintain convertible debt or other similar loss-absorbing instruments sufficient to ensure there is adequate total loss-absorbing capacity to facilitate resolution.
- Congress should prohibit each guarantor from investing in mortgage-related assets or other investments except to the limited extent necessary to engage in the business of securitizing government-guaranteed MBS.
- Congress should restrict the mortgage loans eligible to secure government-guaranteed MBS to loans that have been originated in compliance with safe and sound underwriting restrictions approved or prescribed by the FHFA, including as to responsible down payment requirements, DTI (debt-to-income) limits, insurance, and credit enhancement on high LTV (loan-to-value) loans.
- Congress should amend the Truth in Lending Act to establish a clear bright line safe harbor for compliance with the required ability-to-repay determination.
- Congress should authorize the FHFA to charter competitor guarantors to the GSEs and should direct the FHFA to re-charter each GSE on the same charter available to these potential competitors. Effective as of its re-chartering, each GSE's statutory charter should be repealed.
- Congress should give the FHFA appropriate authorities to foster competition with the re-chartered GSEs.
- Congress should take into account the effects on secondary market competition when considering the legal requirements or restrictions it imposes on guarantors.
Below is a brief overview of HUD's Housing Finance Reform Plan:
- The plan includes a series of recommendations for reforms at the Federal Housing Administration (FHA) and the FHFA with an indication of the Trump administration's views as to which proposals can be achieved through administrative action and which changes would require legislation.
- The recommendations include: "simplifying" the CFPB's Qualified Mortgage (QM) rule, eliminating the so-called QM patch that lets Fannie and Freddie sidestep some regulations and reducing what HUD terms "unnecessary regulatory impediments" for private-label securitization. Most of the changes proposed do not require legislation. The language of many of the recommendations in the HUD plan is aspirational as opposed to being specific and detailed.
- HUD argues that the FHA should refocus on its mission: providing housing finance support to low- and moderate-income families that cannot be fulfilled through traditional underwriting, including targeting first-time and lower-wealth creditworthy homebuyers who benefit from FHA's ability to provide affordable mortgage credit at fixed rates with lower down payments. HUD contends that the FHA has strayed by supporting activities well outside this core mission, unduly risky activities that have materially increased the risks to the FHA's solvency.
- Reflecting its desire to expand the role of private capital and achieve a more limited role for the federal government in the housing finance system, HUD also argues that, through what it calls "a formalized collaborative approach," the FHA and the FHFA must work together to ensure that government-supported mortgage programs are not competing and do not crowd private capital out of the marketplace, both in their single-family and multifamily programs.
We will update this report as developments with respect to housing finance reform warrant
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