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Justin Fitzhugh

A New Mortgage System - Housing, Americas Future Continued

Thursday, September 18, 2014 - Article by: Justin Fitzhugh - Nations Lending Corporation - Message

This is the 5th installment of the series Housing, Americas Future. As I read this study I recognize that some of the policies the study proposed last year are becoming a reality, and I think it important for us, average members of the industry, mortgage branch manager, loan originators, etc. to get a general idea of what may be one of the sources for the policy changes we have observed and yet to come. This study [1] was authored by the Housing Commission and sponsored by the Bipartisan Policy think tank.

Today, I summarize the Commission's recommendations for the Single Family Housing Finance System. In general, the Commission recommended a complete overhaul of the current Housing Finance System that moves away from Government backing and promotes private capital as the main financing source of Housing in America. The central theme of the proposal is an entity the commissions refers to as the Public Guarantor which would have regulating and catastrophic guarantor roles. The goal of the new system would be to maintain opportunities for homeownership and access to credit for responsible borrowers.

Private firms would face the consequences of poor business decisions by losing their capital and would not be bailed by the Government.

The Commission's proposed system of single-family housing finance should have five primary policy objectives:

  1. elimination, phased out over an appropriate period of time, of Fannie Mae and Freddie Mac
  2. the private sectors would have a greater role for the
  3. a continued but limited role for government guaranteed MBS
    1. guarantees would only apply to catastrophic risk
    2. the government guarantee is fully funded and premium collections exceed expected claims
    3. the government guarantee would not cover the equity or debt of the entities that issue or insure MBS
  4. Access to safe and affordable mortgages for borrowers in all geographic markets through complete economic cycles, without discrimination, bias, or limitations not based on sound underwriting and risk management
  5. A continued but more targeted role for the Federal Housing Administration (FHA) which would imply lower loan limits and increased insurance premiums

To enable the participation of private capital in the financing of housing in America, the mortgage market would be structure in such a way that mortgage securitization, servicing, credit enhancement, and catastrophic risk by the government would be ensured.

These functions can be broadly described as follows:

In this redesigned system of single-family housing finance, at least four key functions must be performed after the origination of a mortgage. These functions are (1) securitization; (2) servicing; (3) credit enhancement; and (4) government guarantee for catastrophic risk.

  1. securitization
    1. approved lenders would get certification from the Public Guarantor to issue MBS
    2. would collect the guarantee fee
    3. issue the MBS and sell them to investors through the TBA market
    4. issuers would retain responsibility and representations and warranties under the terms specified by the Public Guarantor
  2. servicing
    1. make timely payment of principal and interest
    2. work with the borrower on issues related to delinquency
  3. private credit enhancers would be single-businesses that would be required to
    1. provide regular report to the public guarantor on the nature of credit enhancement, who holds the risk, the amount and nature of capital they hold
    2. establish underwriting criteria to the mortgages they guarantee beyond the Public Guarantor's criteria
    3. reimburse servicers for their timely payment of principal and interest and other costs at the time the amount of the loan loss if established
    4. establish and enforce servicing standards
    5. provide credit enhancement with standard, transparent and consistent pricing to issuers of all types and sizes
    6. meet credit enhancement requirements
  4. government guarantee for catastrophic risk
    1. guarantee investors the timely payment of principal and interest on the MBS
    2. Establish the level of capital necessary to ensure that private-sector participants in the housing finance system (issuers, servicers, and private credit enhancers are properly capitalized
    3. Provide one common shelf for the sale of government guaranteed securities to offer greater liquidity for the market as well as establish an equal playing field for large and small lenders
    4. Establish a single platform for the issuing, trading, and tracking of MBS
    5. Create and enforce uniform pooling and servicing standards governing the distribution of mortgage proceeds and losses to investors and ensuring compliance with relevant federal tax laws; possibly build upon the work begun by the FHFA
    6. Encourage loan modifications when a modification is expected to result in the lowest claims payment on a net present value basis
    7. Establish the guarantee fees (g-fees) to be collected from the borrower to cover the operating costs of the Public Guarantor and to offset catastrophic losses in the event of a failure of the private credit enhancer and/or servicer failure
    8. Ensure access to the government-guaranteed secondary market on full and equal terms to lenders of all types, including community banks, independent mortgage bankers, housing finance agencies, credit unions, and community development financial institutions
    9. Ensure the actuarial soundness of the fund through careful analysis and the use of outside expertise, and report to Congress regularly regarding the financial condition of the fund
    10. Qualify private institutions to serve as issuers of securities, servicers, and private credit enhancers of MBS
    11. Establish loan limits for mortgages backed by the Government under the direction of Congress,
    12. Set standards for the mortgages that will be included in the MBS, including baseline underwriting criteria, permissible uses of risk-based pricing, and clear rules of the road related to representations and warranties
    13. Specify standards for mortgage data and disclosures

As you may have expected, this will result in higher interest rates, and higher guarantee fees which will be pass to the consumer. The system restructuring would be gradual, and some of the changes would be build upon many of the resources which are currently in place. And whenever we face severe economic downturns, the limited government guarantee for catastrophic risk should help provide for the continued availability of mortgage credit.

I think the commission proposes getting rid of Freddie Mac and Fannie Mae as a way to prevent any future Government bailouts. Clearly the Public Guarantor would be a financially self sufficient entity that would play a very specific role, and from the get go, the policy guiding it would prevent any resemblance with the GSEs. Given that Freddie and Fannie already have clearly defined policies, changing these may represent a tug of war of sorts; hence, the proposal to get rid of these. Well, although plans to dismantle these were quite real, today I am not so sure this will happen. More and more often I hear people in favor of their reforming. Well see...





1) Housing, Americas Future a study sponsored by the Bipartisan Policy think tank, and put together by their Housing Commission:

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