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ABA Policy Recommendations on GSE Policy

The following is a description of the policy recommendations developed by the ABA's GSE Policy Committee and endorsed by the Government Relations Council. These recommendations were also included in a detailed letter from ABA President Frank Keating to the Secretaries of the Treasury and Housing and Urban Development. Click here for ABA Letter.

ABA's GSE Policy Committee has focused on three broad policy questions: What is the desired end point? How do we get there? Who pays and how much? The following paragraphs will discuss each of these questions in turn.

What is the desired end point?

The committee generally agrees that ultimately the role of the government in housing finance should be dramatically reduced from its current level. It is believed that a private market for the vast majority of housing finance should be fostered and encouraged with an ultimate goal of a much smaller governmental role focused primarily on ensuring market stability, access to the capital markets for all originators, and as a safety valve in the event of market failure. More significant government involvement may be necessary and desirable for the creation of affordable rental housing and to assist first-time borrowers or others who may not readily qualify for conventional financing. A well- regulated private market should be the desired financing source for the bulk of borrowers whose income and credit rating qualify them for conventional financing. The committee strongly endorses the continued federal guarantee of existing GSE debt and securities to ensure stability as the process moves forward.

Because of the trauma suffered by the financial markets and the borrowers they serve during the recent financial crisis, it will be necessary to move toward a substantially private market in a cautious and well-considered fashion. A transition period taking a number of years will be necessary.

The committee has not endorsed a specific structure for the GSEs going forward, but instead has considered the mechanisms to be employed to reduce governmental involvement and to foster private sector financing — and to ensure that such financing can involve private sector banks of all sizes. (These specific mechanisms are discussed in the next section under "How do we get there?"). Possible structures for a transition vehicle (and potential end point) include a cooperative structure owned by the financing entities (for issuing securities) and a well-controlled public utility (for providing a limited, fully priced and paid for guarantee for that segment of the market requiring it). Whatever structure is chosen will require significant control and direction of guarantee fees, mission, and investor returns so as to keep it confined to a controlled mission and so that its ultimate success in aiding the return of the private market does not spin out of control and become a rationale for expanding its mission.

It is also the committee's view that rather than developing a single "silver bullet" solution to housing finance, it may be desirable to develop a multiplicity of sources which aid in the reestablishment of a private market. Thus, in addition to the creation of a successor entity or entities to the GSEs, policy makers may want to consider the creation of a well-regulated covered bond market, as well as enhancements to the Federal Home Loan Banks which better help them meet their mission of providing advances to private market portfolio lenders. A multiplicity of sources of liquidity for private market (and especially portfolio) lenders will lead to a more diverse and ultimately safer housing financing system.

How do we get there?

This section deals with the mechanics of moving from the current situation of nearly full government support for the housing finance system to the goal of significantly less governmental involvement and support over a suitable transition period.

The primary mechanism for reducing government involvement (and for compensating the government for the current ongoing support) is through adjustments to the guarantee fees (G-fees) paid to the GSEs (or their successor(s)). Committee members generally believe that the current G fees are too low — that the compensation being paid for what amounts to full government backing is simply not priced correctly. Raising the G fee can do much to encourage development of the private market and to begin to repay the government for its current support. By "dialing up" the G fees in an orderly and well-detailed manner, eventually the private market will find itself in a position where it is better able to compete with the GSEs for business. With a high enough G fee, the private market will be able to price for risk in a fashion that allows for safe and sound investment and lending at a rate that is comparable (and eventually better) than the rate charged by the GSEs. In the meantime, the increased rates for the G fees will help to offset losses and assist in the repayment of the government's investment in Fannie Mae and Freddie Mac. This approach also allows for flexibility in the setting of guarantee fees, thereby ensuring a safety valve for housing finance in the event of private market disruptions.

The other key mechanism to transition to a private market will be the setting of more reasonable loan limits for GSE purchases. The current maximum loan limit of $625,500 in high cost areas and $417,000 in all other regions is dramatically higher than necessary for the purchase of a moderately priced home, especially in light of housing price declines nationwide. While some high-cost areas persist (and a recovery of the housing market will entail a hoped for increase in home values) the conforming loan limits for most of the nation can be reduced further. This will assist the development of a private market for loans outside of the conforming loan limits as a step to a more fully private market for all loans.

Underwriting will also be an important mechanism, but given the significant new underwriting requirements required by the banking regulators and by the Dodd/Frank Act, it would seem that the most important role played by the GSEs in this area for the foreseeable future is to ensure that uniform underwriting requirements are followed by all market participants selling to the GSEs or their successors. The recently finalized Ability to Repay/Qualified Mortgage rulemaking from the Consumer Financial Protection Bureau should lead to a broad category of conservatively underwritten loans (those qualifying for the QM safe harbor) which will not likely require any kind of federal guarantee. Loans outside the safe harbor may require some level of federal guarantee to ensure liquidity for that segment of the market.

Who pays and how much?

These may be the most critical questions, at least in terms of the ability to move forward from the current situation. Any successor entity must be well capitalized with real capital. It is reasonable to expect the users of that entity might contribute to that capital and to the purchase of the hard resources of the existing GSEs which would be used by any new entity, or that a utility-model company might be publicly owned. It is not realistic, however, to imagine that there is capacity within the financial services industry to fully capitalize a new entity in the near term, or to take on the debt of the existing GSEs. It is the committee's recommendation that the increased G fees be used, in part, to begin building capital. This could be achieved by cordoning off the troubled assets of Fannie and Freddie into a segment of the enterprises which would remain in need of federal support. The new book of business, which should consist of higher quality, better underwritten loans — with higher G fees going forward — should provide reasonable returns. Some portion of those returns should be devoted to building capital for the new entity. Other capital will of course come from stock purchases into a new entity (either a cooperative or corporate structure). Ultimately, the troubled assets of the GSEs may have to be separated into a "bad bank" structure and losses realized. However, as the economy recovers some troubled assets may yet be salvaged, and a new healthier book of business will provide returns which can also be used to offset the investment of the government, and ultimately to provide a reasonable return to the investors. Ultimately the returns of the GSEs or the successors must be tightly controlled and limited to as not to provide a rationale to grow the GSEs beyond their mission for profit either to the private sector, the federal government or other interests. In any event, the G fees charged by both the existing GSEs and any successor(s) should be transparent, and should only be used to offset the actual cost of the guarantee, not for other public or private purposes.

The 11 Principles developed by the GSE Policy Committee and endorsed by the ABA's Government Relations Council are:

  1. The primary goal of any government sponsored enterprise in the area of mortgage finance should be to provide stability and liquidity to the primary mortgage market for low and moderate income families.
  2. In return for the GSE status and any benefits conveyed by that status, these entities must agree to support all segments of the primary market, as needed, in all economic environments.
  3. Strong regulation, examination and authority for immediate corrective action of any future GSE must be a key element of reform.
  4. Any GSE involved in the mortgage markets must be strictly confined to a well defined and regulated secondary market role and should not be allowed to compete with the private, primary market.
  5. Any reform of the secondary mortgage market must consider the vital role played by the Federal Home Loan Banks and must in no way harm the traditional advance businesses of FHLBanks or access to advances by their members.
  6. GSEs must both be allowed to pursue reasonable risks, but the risk/reward equation must be transparent and more rigorously defined and regulated.
  7. GSEs must operate within a framework of market procedures and regulation governing the securitization of all mortgage assets.
  8. A better alternative to "skin in the game" is the establishment of strong minimum regulatory standards to assure sound underwriting for all mortgages, regardless of whether they are sold or held. Comparable standards should be established for all loan originators with comparable levels of effective regulatory oversight.
  9. Accounting and regulatory changes should be developed to more appropriately reflect and align securitizations with underlying risks. True sales treatment and regulatory capital charges should appropriately reflect the reality of true risk-shifting activities, as well as balance sheet exposures.
  10. Affordable housing goals or efforts undertaken by the GSEs should be delivered through and driven by the primary market, and should be structured in the form of affordable housing funds available to provide subsidies for affordable projects.
  11. GSEs must provide for fair and equitable access to all primary market lender selling into the secondary market through the GSEs.