The rocky road to GSE reform: no matter who wins the presidential election, proposals to significantly reform the nation's mortgage finance system to replace Fannie Mae and Freddie Mac will still struggle to find consensus in Congress and among industry stakeholders.

AuthorEngland, Robert Stowe

Action on long-overdue mortgage finance reform is low on the policy priority list for the presidential campaigns of both Democrat Hillary Clinton and Republican Donald Trump. [paragraph] Yet, it is an important issue that would likely zoom to the political forefront in the next housing downturn when the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac could well post losses and require a new bailout, according to Mark Calabria, director of financial regulation studies at the Cato Institute, Washington, D.C. [paragraph] Ultimately GSE reform will still depend on reaching a consensus on what elements are in any legislative package. "Congress is not going to pass GSE reform because there is not a broad-based consensus," Calabria says. The lack of consensus will still be there regardless of who wins the White House. [paragraph] "The most likely outcome is that two years from now, Fannie and Freddie will still be in conservatorship," Calabria says.


The political impasse in Congress is strong and entrenched, according to Ed Mills, financial policy analyst at FBR Capital, Arlington, Virginia.

Republicans do not want a federal backstop. This means a new mortgage finance system would have higher-quality loans and less credit availability, according to Mills. "So Democrats are not going to be excited about making credit less available through a system that doesn't have a government backup," he says.

Democrats want to be sure a new system has more credit availability for more people. "That requires a government backstop. Republicans are opposed to that," says Mills.

With the two sides diametrically opposed on seemingly irreconcilable points, there seems to be no way forward. "To solve any problem is to get the other side opposed to you. All of which means GSE reform is the catch-22 of Capitol Hill," Mills says.

The phrase catch-22 was made famous by Joseph Heller's 1961 novel of the same name, in which airmen feign madness to avoid deadly combat missions, but must fly them anyhow because their rational desire for safety shows they are sane.

Mills argues that Congress is more likely to move toward reform in incremental steps, and then "only after significant changes are made to the way Fannie and Freddie operate today, some of which is being implemented by the Federal Housing Finance Agency [FHFA], as we speak," says Mills. The FHFA regulates the GSEs and oversees their conservatorship.

Those significant changes Mills talks about include efforts by the FHFA to create a common securitization platform. It also includes efforts to set up and expand credit risk transfer transactions to move more of the credit risk to the private sector. And it includes programs to develop standardized datasets and standardized technology that can provide loan-level detail to investors.

These ongoing efforts at FHFA and the GSEs "are developing the market underpinnings" for a future mortgage finance system with less systemic risk, according to Ed DeMarco, former acting director of FHFA and current senior fellow in residence at the Milken Institute's Center for Financial Markets, Washington, D.C. They also bring to bear the disciplines of the market by paving the way for the entry of securitization competitors, he adds.

New ideas abound

Whatever the considerable challenges for GSE reform, "I think we're going to see a lot of good proposals," says James Lockhart, vice chairman of WL Ross & Co. LLC, a New York-based subsidiary of Atlanta-based Invesco Ltd., and former FHFA director. Lockhart placed Fannie Mae and Freddie Mac in conservatorship in 2008.

"Hopefully, come January with a new president and a new Congress, we may have people paying attention to the issue," Lockhart says.

The former FHFA director hopes that Congress can build on the successful bipartisan efforts that have advanced GSE reform in the Senate to find a practical, workable approach that ultimately achieves the necessary consensus.

"The issue is not that complicated. It's just very political," Lockhart says.

Presidential leadership could help push GSE reform over the finish line, according to Lockhart. He sees some promise in the fact that both Clinton and Trump have expressed concern about the decline in the share of the population that owns a home since the financial crisis.

The U.S. Census Bureau reported in July that homeownership for the second quarter of 2016 fell to 62.9 percent, the lowest level since 1962. It is significantly lower than the peak rate of 69.1 percent in 2004.

A resolution of the uncertain future of the GSEs is vitally important in view of the fact they still dominate the U.S. mortgage finance system. Together, Fannie and Freddie guarantee or hold $4,585 trillion in mortgages outstanding, according to Inside Mortgage Finance. That represents 48.5 percent of the $10,009 trillion outstanding in single-family mortgages.

The two GSEs also continue to dominate new mortgage origination activity. During the first half of 2016, Fannie and Freddie together funded 42.8 percent of all new mortgages, according to Inside Mortgage Finance.

Mortgage industry leaders are hopeful there will be a better political climate in Washington for GSE reform after the November presidential and congressional elections.

"Clearly the fact that we have a new administration and a new Congress in January 2017 gives us an opportunity to move this whole discussion forward," says Rodrigo Lopez, executive chairman of NorthMarq Capital Finance LLC, New York, chairman-elect of the Mortgage Bankers Association (MBA) and chair of MBA's Task Force for a Future Secondary Mortgage Market (see sidebar, "MBA Task Force Focuses on Affordability").

Clinton and GSE reform

Should Clinton win the presidency and the Democrats retake control of the Senate, the Republicans are likely to retain the House, according to Calabria, complicating any effort by a Clinton administration to tackle GSE reform.

"The odds are that [Rep.] Jeb Hensarling [R-Texas] is again going to be chairing the House Committee on Financial Services next year, and he's not going to roll over for just any deal," Calabria says.

The Democratic Party's platform lacks specifics about how GSE reform might be approached if it becomes a priority. The platform defends the regulatory framework created by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, including the creation of the Consumer Financial Protection Bureau (CFPB), and vows to fight any efforts to roll back any of the provisions in Dodd-Frank.

Both Lockhart and Calabria say that a Clinton administration is likely to develop an approach to GSE reform that builds on the strengths of the current system and the progress made in building elements of a new system at the FHFA and the GSEs.

Indeed, the 2016 Democratic Party platform has little to say about mortgage finance except to call for the preservation of the 30-year fixed-rate mortgage.

Clinton provided some detail on her housing agenda in February when she laid out some of the policy details in a briefing paper titled Hillary Clinton's "Breaking Every Barrier Agenda": Revitalizing the Economy in Communities Left Behind.

In one proposal, Clinton called for a program that would provide up to $10,000 to match an equivalent amount of savings by households to help accumulate a down payment for a home purchase.

One template for what might emerge in a Clinton administration is a March 2016 proposal titled A More Promising Road to GSE Reform, put forward earlier this year by Jim Parrott, Mark Zandi and others. Parrott is senior fellow at the Urban Institute, Washington, D.C., and owner of Falling Creek Advisors LLC, a consulting company based in Chapel Hill, North Carolina; and Zandi is chief economist at Moody's Analytics, West Chester, Pennsylvania.

The proposal is also co-authored by mortgage securities pioneer Lewis Ranieri, founding partner and chairman of Ranieri Partners Management LLC, Uniondale, New York; Gene Sperling, former director of the National Economic Council under both President Bill Clinton and President Barack Obama; as well as Barry Zigas, director of housing at the Consumer Federation of America, Washington, D.C.

"It's essentially a government model with broad-based guarantees of mortgage-backed securities [MBS]. It is also going to be geared toward wide credit availability," Calabria says.

More details about the plan from Parrot et al can be found in a June 2016 paper by the same five co-authors titled: A More Promising Road to GSE Reform: Governance and Capital. The paper fleshed out more of the details of how a new government corporation, the National Mortgage Reinsurance...

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