A Treasury Department official said today that despite arguments that Fannie Mae and Freddie Mac (the GSEs) are financially flush and that, with the confirmation of Mel Watt as Director of the Federal Housing Finance Agency (FHFA) the administration can now accomplish its goals without the help of Congress, it is critical to continue the pursuit of comprehensive housing finance reform. 

Secretary for Housing Finance Policy Dr. Michael Stegman told a meeting of the ABS Structured Finance Industry Group many of the structural flaws of the legacy GSE-centric mortgage finance system have not been fixed.  Indefinitely continuing a taxpayer-backed duopoly is neither sustainable nor sensible public policy.

First, the GSEs might not be that flush.  He said that recent quarterly results may "significantly overstate the true financial condition of the enterprises, especially on a go-forward basis."  Some recent income has resulted from one-time tax reversals, releases of loan loss reserves, or settlements of legacy securities litigation.  Excluding these, in the first three quarters of 2013 more than 60 percent of the GSEs' combined income was from their retained investment portfolios which they are required to steadily shrink under their agreements with Treasury.  They have also benefited significantly from strong home-price appreciation and low interest rates, both of which may moderate in future periods. 

Further, he said, keeping the GSEs in a conservatorship designed by emergency legislation is not the best way to operate over the long term and continued uncertainty about their future will continue to impede access to credit.  Thus comprehensive housing finance reform remains a top Administration priority.

Stegman said the President has outlined his objectives for that reform; require private capital to play the dominant role in providing mortgage credit; ensure creditworthy borrowers have broad access to safe and responsible mortgages; put in place strong safeguards to protect taxpayers; and help ensure access to affordable rental options for middle class families and those who are working toward joining the middle class.  The following are priorities.

• Preserving a deep and liquid TBA market. A catastrophic government guarantee of qualified mortgage backed securities (MBS) standing behind substantial private capital in a first loss position is critical to maintaining market liquidity and preserving broad access to the 30-year fixed rate mortgage. GSEs' legacy securities must have a comparable guarantee.

A good first step toward this would be to reduce the price gap between Freddie Mac's securities and Fannie Mae's by linking them.  This would reduce the cost to taxpayers and improve liquidity in the TBA market.

• The holding or syndicating of credit risk should be separated from the act of securitizing mortgages. This would help prevent entities holding credit risk from becoming too important to fail because they also control the infrastructure needed to create securities. It would also lower the barriers to entry. "Our preference would be that all single-family mortgages that receive a government-backed wrap be securitized through a single, non-profit securitization utility that would issue standardized mortgage backed securities."

• To attract significant private capital to take credit risk, the regulator should be able to approve various forms of first loss as long as they meet specified criteria. Allowing different types of first loss mechanisms can help attract a wide source of private capital to take credit risk.

There are two phases of the mortgage credit cycle in which alignment of interest issues arise between the first loss-taker and the government: (1) when mortgage pools are formed; and, (2) throughout life of the loan.  The interests of the Guarantor entity and the government are powerfully aligned where a well-capitalized guarantor is responsible for paying all credit losses on a given pool and the government guarantee is triggered only when all of its capital is exhausted.

•  Creditworthy borrowers in all geographies, and with varying income levels, must have access to the system. All originators, guarantors, and aggregators within a government guaranteed system will be required to provide mortgage credit on an equitable and non-exclusionary basis with a strong independent regulator available to enforce compliance.

• The future system must provide liquidity to the rental market. The new system should have many more participants and be more competitive than the current marketplace, where the GSEs dominate. Stegman says the Administration supports repeal of GSE affordable housing goals but would incorporate affordability standards for multifamily housing into the new system.

• The new system should include a national mortgage database. The recovery was hampered by the low quality and idiosyncratic coverage of mortgage data such as information to assess risk or to identify and link senior and junior liens. A comprehensive database covering residential loans and liens would be a significant step to improve these data failures.

• The transition must be done in a way that does not disrupt liquidity and access to credit and will take time, at least five years. In the lead up to a successful transition, the GSEs should ramp up their risk sharing transactions, and make strong progress on their Common Securitization Platform, since a single securitization utility is central to the future system. The Administrations also wants to see a number of new guarantors during the transition period prior to terminating the GSEs' authority to do new business.

A robust non-agency private label securitization market is crucial to any future system and increasing guarantee fees is necessary but not sufficient to insure the re-entry of private capital.  Stegman said as he looks at the three crucial focal points of reform he sees a new confirmed director of FHFA, a bipartisan commitment to reform on the part of the Senate Banking Committee, and sees "one glaring void." 

"Where can we turn to find the focal point for reforming and reinvigorating the private label securities sector? Where is the center of gravity for addressing standards around reps and warranties, trustee obligations, data and disclosure, loss mitigation, and related issues? In the absence of an apparent leader, Treasury plans to coordinate a series of conversations with relevant regulators, market participants, and other stakeholders to help accelerate necessary reforms in the non-agency space. 

Stegman also told the group that Treasury is not in favor of extending the eligibility for refinancing under the Home Affordable Refinance Program (HARP) to loans originated after the current May 31, 2009 cutoff date.  Very few homeowners whose loans were originated after that date are underwater, he said, and changing the date would prolong market and investor uncertainties.  But, he added, we must remember the inability of performing underwater borrowers whose loans are held in private label security trusts to refinance, a situation which has motivated some communities to suggest using eminent domain to seize and "right size" residents' mortgage debt.  "As we work to reform the housing finance system, we will seek to ensure that neither the source of one's mortgage nor who owns the credit risk should determine a borrower's eligibility for refinancing or mortgage assistance."