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From Banking and Finance Law Daily, October 8, 2014

GAO develops framework to assess housing finance reform proposals

By Colleen M. Svelnis, J.D.

The General Accountability Office has developed a draft framework that can identify the relative strengths and weaknesses of any housing finance reform proposals. The framework is included in the GAO report, “Housing Finance System: A Framework for Assessing Potential Changes.” In developing the report, GAO reviewed literature on housing finance and housing market developments and also met with officials from a number of federal agencies. The draft framework was shared with seven discussion groups composed of government officials, experts from academia and research organizations, and interested parties such as consumer advocates and industry representatives. These groups provided input on market developments and the framework.

Reforms needed. The report describes how developments in mortgage markets since 2000 have challenged the housing finance system and revealed or led to weaknesses in that system. These include misaligned incentives, an overall lack of reliable information or transparency, and excessive risk taking. The Federal Housing Finance Agency and the Consumer Financial Protection Bureau were created to address regulatory gaps to oversee the enterprises, protect consumers, and provide better information to the public.

During the financial crisis, the Federal Reserve System and the Department of the Treasury began purchasing mortgage-backed securities (MBS) issued by the enterprises. The Fed began reducing these purchases in January 2014, and Treasury completed the sale of its MBS investments in fiscal year 2012. The report further states that in 2013 the federal government was providing support either directly or indirectly for 81 percent of the value of all new mortgages.

The GAO highlighted the following examples of problems in the housing finance system:

  • originators’ and private-label securitizers’ incentives were not aligned with those of borrowers and investors, because originators and private-label securitizers generally did not retain credit risk;

  • some borrowers lacked reliable and relevant information to adequately understand the risks of mortgage products because originators were not required to share certain information; and

  • a loosening of underwriting standards prior to the financial crisis likely led to excessive risk taking by borrowers.

Developing the framework. The GAO has provided a framework to help assess proposed changes in the housing finance system. The framework could be used to craft new proposals and to help policymakers understand the risks associated with transitioning to a new housing finance system.

The report lists nine elements that the GAO uses to apply to the framework to help reveal the relative strengths and weaknesses of any proposal for change and identify what are likely to be significant trade-offs among competing goals and policies. The GAO believes each element in the framework is important in establishing the most effective and efficient housing finance system. The GAO hopes that applying the elements of this framework will help policymakers identify the relative strengths and weaknesses of any proposals they are considering.

Additionally, the report states that the framework can be used to craft proposals or to identify changes to existing proposals to make them more effective and appropriate for addressing any limitations of the current system.

The nine elements listed are:

  • clearly defined and prioritized housing finance system goals;

  • policies and mechanisms that are aligned with goals and other economic policies;

  • adherence to an appropriate financial regulatory framework;

  • government entities that have capacity to manage risks;

  • mortgage borrowers are protected and barriers to mortgage market access are addressed;

  • protection for mortgage securities investors;

  • consideration of cyclical nature of housing finance and impact of housing finance on financial stability;

  • recognition and control of fiscal exposure and mitigation of moral hazard; and

  • emphasis on implications of the transition.

Proposed legislative reforms. Several bills have been introduced in Congress seeking to further housing finance reforms. Senate Bill 1217, introduced by Sens. Robert Corker (R-Tenn) and Mark Warner (D-Va), would overhaul the mortgage-backed securities markets and reform the government-sponsored enterprises; require that private market participants hold 10 percent of the first loss of any mortgage-backed security that purchases a government reinsurance wrap. Two other bills that build on this proposal are the Housing Opportunities Move the Economy (HOME) Forward Act in the House, introduced by Maxine Waters (D-Calif) and the Housing Finance Reform and Taxpayer Protection Act of 2014, which was introduced by Sens. Tim Johnson (D-SD), and Mike Crapo (R-Idaho).

Another reform bill is the Partnership to Strengthen Homeownership Act, introduced by John Carney (D-Del), John K. Delaney (D-Md), and Jim Himes (D-Conn). Under this proposed legislation:

  • Fannie Mae and Freddie Mac would be phased out, providing a return to taxpayers with interest;

  • affordable federal and state housing programs would be supported by the Housing Trust Fund, Capital Magnet Fund, and Market Access Fund;

  • the 30-year fixed mortgage would be retained, and sudden reductions in mortgage credit avoided; and

  • credit would be available during times of market stress and lending standards normalized.

The Protecting American Taxpayers and Homeowners Act (PATH Act), H.R. 2767, was introduced by Scott Garrett (R-NJ) last year, and proposed to:

  • end the Fannie Mae and Freddie Mac bailout and set a five-year time limit within which to liquidate them and sell off any remaining assets;

  • target the FHA’s mission to first-time borrowers and low- and moderate-income borrowers;

  • establish a new non-government, not-for-profit National Mortgage Market Utility regulated by the Federal Housing Finance Administration to develop common “best practices” standards for the private organization, servicing, pooling, and securitizing of mortgages, and operate a publicly accessible securitization outlet to match loan originators with investors;

  • institute a mandatory two-year “stop-and-study” delay regarding the implementation of Basel III capital rules, during which time regulators would be required to review the impact, cost, and complexity of Basel III rules regarding banks and local lending;

  • repeal the Dodd-Frank Act’s credit risk retention requirement and prohibit the Dodd-Frank Act-inspired “Premium Capture Cash Reserve Account” rule;

  • regarding implementation of the Volcker Rule, exclude issuers of asset-backed securities from the proposed definition of “Covered Funds”; and

  • ensure that the Securities and Exchange Commission’s implementation of its Regulation AB II rule, which imposes requirements for the registration, disclosure, and reporting of all publicly registered asset-backed securities, does not negatively impact issuances, including mortgage-backed securities.

Companies: Fannie Mae; Freddie Mac

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