Category: Blog

Blog: 2017: An Opportunity to Coordinate America’s Housing Policy

Posted on by Lindsey Johnson

By Lindsey Johnson

While the housing finance system in the United States has developed into an ad hoc set of entities and programs, so has the regulatory system around it with more than seven[i] federal agencies playing a role in the formation of policy and regulation of activities for housing finance. Despite the expansive reach of the federal government in the housing finance system and the exhaustive list of government agencies regulating it, safety and soundness gaps exist, access to credit remains tight, and potential homeowners continue to fall through the cracks. Housing policy has become political in addition to being complex and has therefore created an environment where meaningful reforms are rarely achieved. However, the outcome of the historic 2016 election means that one party will control all three branches of government starting in 2017, which presents a unique opportunity to examine the underpinnings of the housing finance system and establish a more comprehensive and coordinated approach to housing policy, rather than just tinkering around the edges of the mortgage finance industry.

Here are three overarching housing considerations and recommendations for the new Congress and Administration:

  1. There is a need for more coordinated, comprehensive, and transparent federal housing policy.
  2. All attempts to reform the housing finance system should fix the parts of the system that were and are broken, while enhancing the parts of the system that work. Part of the solution to fix what is broken is to identify and address areas of inconsistency and redundancy.
  3. Private capital should play a much greater role in the housing finance system. There should be a regulatory body that sets safety and reliability rules for market players on an equitable basis. Further private capital, not government and taxpayers support, should be encouraged to provide access to credit and protect against credit risk where possible in the housing finance system.

Since major housing policy tends to be reactionary and seldom comprehensive, inconsistencies and overlaps have developed resulting in dramatic shifts between the completely private market (PLS market), the semi-government backed market (conventional market via Fannie Mae and Freddie Mac), and the fully government-backed Ginnie Mae market (FHA, VA, and USDA). One such area of inconsistency is in low downpayment lending, which is increasing as a proportion of the overall residential mortgage market. Currently, a single borrower is subject to different requirements and pays different premium rates for insurance or a guarantee on a low downpayment loan under private mortgage insurance (MI), the FHA, the USDA’s Rural Housing Service, the Department of Veterans Affairs, or state Housing Finance Agency programs—even though the borrower’s risk profile remains the same.

A coordinated policy would inform how low downpayment lending in the U.S. is carried out. For example, it is common in other types of insurance such as crop, flood and terrorism insurance, to limit government programs to higher risk borrowers or to condition access to supplemental capacity by requiring some demonstration of the need for that capacity. The FHA’s current loan limits do not provide a level playing field nor is there a direct preference for a private capital alternative.  Instead, any preference is done indirectly through premium rate setting and competition, which results in an unstable policy environment. The resulting outcome is dramatic fluctuations between these mortgage finance markets, which at times is most evident between the private mortgage insurance market and the 100% government-backed mortgage insurance market at FHA. While it may seem normal to have some fluctuations during different housing cycles, the recent market fluctuations have most often been the result of competition for market share between the two. This is neither conducive for the most efficient and effective mortgage finance market nor does it ensure that borrowers are being best served. Furthermore, there are redundancies and significant overlap between several government agencies such as FHA and the Rural Housing Service (RHS), where on repeated occasions the GAO[ii] and others have suggested consolidating the agencies or at least specific areas of intersection between them.

Of course a true comprehensive, coordinated housing policy will require reform of the GSEs—or as previously stated, fixing the parts of the housing finance system that were and are broken while enhancing the parts of the system that work. Although housing finance reform may not be the first focus of the new Congress and Administration, significant steps could be taken in the near-term to encourage greater reliance of private capital and market discipline in the housing finance system by establishing clarity about the roles of the different agencies in facilitating homeownership and by providing much greater transparency at both FHA and the GSEs about how these agencies price credit risk. Again, this difference between agencies is particularly sharp in the case of FHA and the conventional lending space with Fannie Mae and Freddie Mac, which use private capital, such as private MI, to insure against a portion of first-loss on high LTV loans. However, in this case, a single borrower either pays a premium rate determined on an average basis (FHA) or a risk-based one (private MI), with the risk-based premium driven by “asset requirements” established by the government-guaranteed GSEs but not by the government-guaranteed FHA. So while there continues to be bipartisan support for reducing the government’s footprint and reducing taxpayers’ exposure to mortgage credit risk, the current market’s inconsistencies are considerable roadblocks to achieving that goal.

There are a number of different proposals for reforming the housing finance system, but most essential going forward is that Congress fixes one of the greatest flaws of the previous and current system, namely that government-backed entities – whether completely government controlled such as FHA or quasi-government such as the GSEs – should not set rules for and then compete on an unlevel playing field with the private market. These entities should perform explicit functions that foster greater participation by the private market, should promote a race-to-the top and not a race-to-the-bottom, and should be highly regulated. They should also be completely transparent in the credit risk they guarantee and how they price that credit risk. Transparency about how government prices credit risk would facilitate the greatest level of liquidity in these markets, and for credit risk transfer would foster an understanding of how these transactions are priced and the best execution for each. Finally, providing greater transparency will help end a structure where only a few agencies control the housing finance system because of their ownership of proprietary data, systems, and pricing. In conservatorship, the GSEs have an explicit guarantee on their Mortgage Backed Securities from the federal government. Therefore, until comprehensive housing finance reform is realized, critical steps could be taken now to improve transparency and foster greater understanding by market participants that will ultimately better inform borrowers. More transparent pricing will benefit lenders, investors, and most of all consumers and taxpayers.

As stated by former FHFA Director Ed DeMarco, housing finance reform “remains the great unfinished business from the Great Recession.” The complexity and political nature of the issues surrounding housing finance reform make it a daunting task to be sure, but the new Administration and Congress have a unique opportunity to make the housing finance system more coordinated, transparent, and disciplined to work for taxpayers and borrowers.

[i] Federal agencies involved with housing finance policy and regulation include FHFA, HUD, VA, USDA, Treasury, NCUA, and CFPB

[ii] U.S. Government Accountability Office, HOME MORTGAGE GUARANTEES: Issues to Consider in Evaluating Opportunities to Consolidate Two Overlapping Single-Family Programs (September 29, 2016).  See http://www.gao.gov/assets/690/680151.pdf.

Newsletter: October 2016

Posted on by Rhina Portillo

On October 13, the comment period closed for the Federal Housing Finance Agency (FHFA)’s Single-Family Credit Risk Transfer (CRT) Request for Input (RFI). Below is a roundup of the comment letters submitted by USMI and numerous other housing finance organizations that expressed support behind efforts to reduce government, and therefore taxpayers’, risk exposure by positioning more private capital in a “first loss” position ahead of the government sponsored enterprises (GSEs) through expanded mortgage insurance.

  • USMI notes in its comment letter the distinct advantages of front-end CRT done through expanded use of MI: “Increasing the proportion of front-end CRT in the Enterprises’ CRT strategy will advance four key objectives of a well-functioning housing finance system by ensuring that: (1) a substantial measure of private capital loss protection is available in bad times as well as good; (2) such private capital absorbs and deepens protection against first losses before the government and taxpayers; (3) all sizes and types of financial institutions have equitable access to CRT; and (4) CRT costs are transparent, thereby enhancing borrower access to affordable mortgage credit.” These comments were further highlighted in an article by the Mortgage Professional America magazine. The full comment letter is available here. USMI’s RFI fact sheet can be found here.

Following the submission of USMI’s comment letter, an op-ed by USMI President Lindsey Johnson was published in The Hill that echoes the benefits provided to the GSEs and US taxpayers by front-end CRT through expanded use of MI.

  • A number of other stakeholders and organizations also weighed in, supporting efforts to expand the use of MI:
    • Urban Institute wrote: “The GSEs could share additional credit risk through this channel by having some MIs cover a deeper level of first loss, down to, say, an effective LTV of 50%. So-called deep cover MI has several attractive features. First, it extends a structure already in wide use, making it easy for lenders of all sizes to adopt. Second, in contract to the front-end structures used to date, it is equally available to and can be equally priced for lenders of all sizes. Third, it is completely transparent… Since mortgage insurance is the only product MIs offer, they will provide capital in good times and bad.”
    • National Association of Home Builders wrote: “Deep coverage MI would allow mortgage insurance companies to reduce the Enterprises’ exposure to credit losses to as low as 50 percent of the mortgage loan amount. The Enterprises would reduce their guarantee fees on the mortgage loans commensurate with the cost of the risk they transfer to the mortgage insurers. The reduced guarantee fee charged by the Enterprises in exchange for incurring less credit risk can be passed on to consumers, reducing the cost of the mortgage loans and increasing the availability of credit.”
    • Mortgage Bankers Association wrote: “Up-front risk-sharing structures with committed mortgage market participants such as lenders, mortgage Real Estate Investment Trusts (REITs) and mortgage insurers can distribute mortgage credit risk prior to the loan(s) being acquired by the GSEs, while offering potential borrower benefits… Well-conceived up-front risk sharing pilot programs, such as expanded lender recourse offerings, deeper mortgage insurance or other capital markets structures that are executed prior to GSE acquisition, can help the GSEs better determine which transaction structures are best able to expand the sources of private capital and withstand both the peaks and valleys in the credit cycle.” These comments were further highlighted in an article by Scotsman Guide.
    • Community Mortgage Lenders of America wrote: “There is no substitute for the depth of experience, the broad web of customer relationships and level of service that the MI industry provides to lenders, nor to the key role played by mortgage insurers in facilitating low down payment lending for borrowers whose home finance needs are served with a low down payment mortgage.”
    • Credit Union National Association wrote: “… private mortgage insurance needs to be maintained as an option as it can be utilized as an effective risk transfer strategy.”
    • Housing Policy Council wrote: “We specifically recommend that FHFA and the Enterprise test deeper mortgage insurance through a pilot program. Of the various structures discussed in the RFI, only deeper mortgage insurance has yet to be tested in the marketplace.”

In addition, last week the Congressional Budget Office (CBO) released a report entitled “The Effects of Increasing Fannie Mae’s and Freddie Mac’s Capital.” The October 20th report came at the request of Senate Banking Committee Chairman Richard Shelby (R-AL) and analyzes a policy that would allow the GSEs to increase their capital by reducing payments to Treasury, as well as discusses the effects it would have on the federal budget and the U.S. mortgage market.