June 27, 2018

Administration Call to Reorganize Federal Government Also Proposes Changes to Housing Finance System

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Last week, nestled within the Administration’s sweeping proposal to reorganize the Federal Government was the loose framework of a proposal to make major changes to the nation’s housing finance system under the umbrella of reform. 

In a scant two-and-a-half pages, the proposal calls for ending the conservatorship (and charters) of Fannie Mae and Freddie Mac (collectively, the Government Sponsored Enterprises or GSEs), creates a paid-for guarantee of catastrophic risk on mortgage-backed securities, and encourages the establishment of other fully private guarantors. It would eliminate guarantors’ responsibility for ensuring broad market access or any affordable housing activities, instead shunting low- and moderate-income borrowers to the Federal Housing Administration (FHA) -- an idea that should be a non-starter.

We have previously written about the need for housing finance reform and have offered policy recommendations for creating a more stable, accessible, and affordable system of mortgage finance in the United States. We will use those recommendations as a guide for evaluating the new proposal. 

The proposal is entirely silent on the future of rental housing finance and the GSEs’ multifamily business lines. One might infer from the proposal’s full privatization of the GSEs that the multifamily business lines would remain intact in any transition, but elimination of their charters and new “mandates focused on defining the appropriate lending markets” might lead the GSEs and any new competitors to abandon financing housing that serves extremely low-income and very low-income renters, or even moderate-income renters, choosing instead to chase the luxury rental market. In contrast, the GSEs’ current affordable housing goals require actively supporting the mortgage needs of multifamily properties that largely serve lower-income renters. Taken more broadly, these goals reflect the public purpose obligations that accrue to chartered institutions that have access to a public backstop or other benefits.

As a core principle, we believe that any changes must establish an explicit, limited and paid-for government guarantee on qualifying single-family and multifamily mortgage-backed securities (MBS), with private investors taking a loss before taxpayers. From that perspective, the proposal is largely in line with the mainstream, bipartisan consensus that there is an appropriate role for a paid-for government backstop that would limit investor losses on MBS without guaranteeing the entities issuing them. The proposal largely mirrors the general approach taken by the bipartisan Housing Finance Reform and Taxpayer Protection Act (Johnson-Crapo), which passed the Senate Banking Committee in May 2014, as well as proposals from the Urban Institute and the Mortgage Bankers Association. It implicitly rejects the Republican-led Protecting American Taxpayers and Homeowners Act (PATH Act), which passed the House Financial Services Committee in 2013 through a party-line vote and would gradually wind down the GSEs, resulting in a fully private mortgage market with no explicit guarantee from the federal government.

The proposal makes a critical mistake in assuming that affordable housing objectives and traditional underwriting are mutually exclusive and therefore would shift primary responsibility for serving low- and moderate-income borrowers to HUD and FHA. Eliminating any obligations for guarantors to serve lower-income borrowers would establish a two-tiered market and, given the known disparities in income and wealth between white and minority borrowers, raise questions of fair lending and disparate impact. Without a mandate that requires guarantors to broadly serve the market, the system the Administration envisions may simply subsidize home purchases (and refinancing) by the wealthiest households. 

Interestingly, this proposal departs from Johnson-Crapo and the Mortgage Bankers Association approach (but is consistent with the Urban Institute’s recommendations) by establishing an affordability fee to be levied on outstanding MBS issued by guarantors rather than on new purchases. By basing the assessment on outstanding MBS, the proposal allows for greater certainty around annual funding levels for affordable housing activities than a fee connected to new purchases, since the latter is subject to the business cycle. Presumably, the affordability fee would continue to fund the National Housing Trust and Capital Magnet Funds, just like the current 4.2 basis point assessment on the GSEs new business does, but a discussion draft of legislation that circulated earlier this year would have used the majority of the fee for downpayment assistance and interest rate buydowns. We believe the housing finance system should be designed from the start to serve those buyers affordably, and any affordability fees should be used to support the housing needs of the lowest-income families first.

The proposal seeks to protect taxpayers through a paid-for, limited guarantee on MBS. In shifting all low- and moderate-income borrowing to FHA, however, there is significant risk that across the housing finance system, taxpayer exposure might be increased rather than reduced, because FHA’s activities are entirely on the federal balance sheet and have no private capital sitting ahead of any FHA-insured losses. (In contrast, any guarantee fees paid by future guarantors could flow into an FDIC-like fund with the ability to both pre- and post-fund any payments to make MBS investors whole. The current proposal calls for the guarantee fund to be on the federal budget, however.) In a desire to avoid cross-subsidization of activities, the proposal fails to recognize that all lending entails a degree of cross-subsidy, since the future performance of any loan can never be known in advance. We encourage a robust discussion of the appropriate level of cross-subsidy within any particular portfolio and across the system overall, using what we know about the ability to responsibly lend to borrowers at a range of incomes and with a range of down payments as a guide.

Some commentators have speculated that the proposal drafted by the Office of Management and Budget lacks consensus within the administration, while others have pointed to the congressional calendar to suggest that legislative activity is unlikely in 2018. Nevertheless, we will continue to remain engaged on this critical issue and work towards a future system that is structured to protect taxpayers while broadly serving the needs of homeowners and renters.