The House Financial Services Committee conducted hearings on Wednesday on Government Barriers to the Housing Market Recovery, hearing from speakers representing three government agencies and four representatives from the private and quasi-private sector.

David Stevens, Assistant Secretary for Housing and Commission of the Federal Housing Administration (FHA) told the committee that the Obama administration feels it is essential to facilitate the return of private capital to the mortgage markets as the government scales back its current historically oversized footprint.  Stevens outlined the progress that FHA has made in restoring its capital reserves, improving loan quality, and reducing its exposure to risk but said Congress needs to pass comprehensive FHA reform legislation that enhances FHA's lender enforcement capabilities and risk management efforts.

The Obama Administration's recent report to Congress on housing finance reform set out three options for such reform; the Administration believes FHA is the common thread and must be part of facilitating the return of private capital and a more balanced national housing policy.

The first option would target government's sole role in insuring or guaranteeing mortgages to creditworthy lower-and-moderate-income borrowers; leaving the vast majority of the mortgage market to the private sector.  Option Two would complement the FHA role with a backup mechanism to ensure access to credit during a housing crisis and the third option would include, alongside the FHA, limited government reinsurance of a targeted range of mortgage securities that would be designed to increase liquidity and access and respond to future crisis.

Under the first option the maximum loan size for FHA insurance would be reduced, initially by allowing the present increase in those limits to expire as scheduled this October 1.  FHA will work with the Federal Housing Finance Agency (FHFA) to pursue increased pricing for guarantees by the government sponsored entities (GSEs) as well as additional increases for FHA insurance.

Stevens stressed that government cannot abruptly and prematurely withdraw its current support without harming the housing market and severely affecting home prices.  Housing reform must also be pursued in a fair and equitable way so that all Americans have access to a choice of affordable housing and government must work to fix "the fundamental flaws that occurred at every link in the housing finance chain."  These flaws allowed too much risk to build and inflict severe harm on homeowners, lenders, investors, and the greater economy, but work is already underway through Dodd Frank and HUD's work to explore alternative servicing compensation structures.

Stevens said that taking steps to ensure that Americans have access to an adequate range of affordable housing options does not mean that all Americans should become homeowners.  A national housing policy:

• Would ensure that people who are in a financial position to own a home have access to the capital needed to do so;
• Guarantee that families are not set up to fail with mortgages that enable them to buy homes they simply cannot afford.
• And it would make financing available to those who will build the rental housing needed to provide choices for the growing number of families for whom homeownership may not be the best option.

Theodore "Ted" Tozer, President, Government National Mortgage Association (Ginnie Mae) said the current market in which the GSEs and Ginnie Mac guarantee 95 percent of mortgage-backed securities is unsustainable.  For investors, uncertainty about the future of the GSEs impacts decision making and as long as the GSEs offer an outlet for mortgage loans with below market pricing, private label securities will be disadvantaged.  Current plans to increase GSE guarantee fees, increase the capital ahead of the guarantees and wind own their investment portfolios will end uncertainty and create space for greater private sector investment.

Tozer said that the current private label securitization process works with limited oversight.  Bond trustees are currently responsible only for distributing monthly interest and principal payments to investors but, to restore trust and integrity to the market we may need to consider expanding their role and authority to include making sure loans are serviced properly.  They may also need authority to require repurchase of defective loans or to require issuers to cover catastrophic loss.

Panel II of the hearing consisted of testimony from Douglas Holtz-Eakin, President, American Action Forum; Michael A. J. Farrell, Chairman, President, and CEO, Annaly Capital Management, Inc.; Faith Schwartz, Executive Director, HOPE Now; and Julia Gordon, Senior Policy Counsel, Center for Responsible Lending.

Holtz-Eakin framed his remarks around two points:

• Adoption of appropriate housing finance polices will aid the pace of economic growth and job creation by stabilizing household balance sheets and clarifying single- and multi-family investment incentives;
• There are good, pro-growth reasons to rethink the policy of supporting debt-financed owner-occupied housing through tax and regulatory subsidies.

There are, he said, two channels by which housing finance policy will affect the pace of economic growth; housing valuations and new construction incentives. Housing values are under stress because of excess inventory; the best way to speed progress would be to get federal policy out of the way.  Valuations also depend on purchasers' expectations of future policies including deductibility of mortgage interest, subsidies for energy-efficient investments, and guarantees for conforming mortgage securitization.  Similar considerations apply to how housing affects growth through construction.  Incentives to build depend on the expectations for low-income tax credits and other federal policies. The sooner both types of policy decisions are made, the sooner housing will stop dragging on job creation and growth.

Housing is heavily regulated; however the dominant federal policy is one that provides subsidies to the debt finance of owner-occupied housing.  Holtz-Eakin said the recent housing bubble and current market conditions indicate that this has not served market participants well and the committee should step back and answer key questions about the policy framework such as whether the government should subsidize any housing and if so, what type?  Should subsidies be provided directly to owners and renters or through builders and sellers of properties?  Should subsidies depend on the mixture of debt and equity finance?  Will they be transparently displayed in the budget and controlled by Congress or will the government continue to provide "virtually open-ended mortgage subsidies through the tax code and off-the-books finance subsidies via the GSEs?   

Farrell, whose company is the largest residential Real Estate Investment Trust on the New York Stock Exchange said that secondary mortgage market investors provide 75 percent of the capital to the US housing market, a total of about $7.5 trillion in MBS.  Since the country's banks have about $12 trillion in total assets, there is not enough money in the banking system to fund the nation's housing stock at current levels so it is axiomatic that a healthy securitization system is essential. 

At present the securitization market is attracting significant amounts of private capital to the securities with a government-wrapped but the credit-sensitive non-Agency or private-label market is dormant with only one small deal done in the last 2-1/2 years.  This market is not restarting because:

• The math doesn't work. Either primary mortgage rates have to rise, the rating agencies' senior/subordinate splits have to come down, and/or return requirements by the secondary market have to decline.
• There is a higher yielding alternative; legacy private label MBS and seasoned loans that have been repriced by the market.
• It is difficult sourcing enough newly originated loans. As a result banks have gotten comfortable with keeping non-conforming loans on their balance sheets but only after tightening underwriting standards. As long as these stringent standards remain, Farrell said, he doesn't see a vibrant private-label market developing.
• There is uncertainty over the future regulatory environment related to qualified residential mortgages and Basel III.

The private label MBS market can come back to fill the credit gap currently occupied by the GSE's, he said, but not at the same price and not in the same size.  Money Markets, mutual funds, banks, foreign investors, and governmental agencies won't invest in private label MBS because their investment guidelines preclude taking credit risk.  "At the end of the day," Farrell said, I have to refer back to my two market truths:  Securitization is the source of 75 percent of the capital to the housing market, and the private label securitization market isn't working right now."

Schwartz said in order to create a climate in which investors will return to the markets there will have to be transparency, reliability, and market integrity.  There is a need for uniformity and clarity in such areas as servicing standards for mediation and for the length of the foreclosure process.  Representations and warranties must be clear and enforceable as must borrower credit risk.  The price of loss mitigation needs to be assessed to ensure proper fee structures and external risks such as enhanced regulation taken into account. 

Gordon offered a list of recommendations for Congress, Federal Agencies and the states as well as a list of suggestions for improving the operations of the HAMP loan modification program.

Among her recommendations for Congress were:

• Mandate loss mitigation prior to foreclosure
• Level the playing field in court by providing legal assistance for homeowners;
• Protect homeowners from the tax ramifications of mortgage debt forgiveness;
• Change the bankruptcy code to permit modification of mortgages on principal residences.

Recommendations to federal agencies included:

• Aggressively enforcing servicing rules, especially those related to loss mitigation;
• The new Consumer Financial Protection Bureau should make servicer oversight and enforcement a top priority;
• Regulators involved in creating the QRM exception should not impose a hard down payment requirement for all borrowers.

In addition to mandating loss mitigation prior to foreclosure, states should exercise supervisory and enforcement authority over servicers doing business in their jurisdictions.