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From Banking and Finance Law Daily, November 22, 2013

Hearing explores regulatory structure for reformed housing finance system

By John M. Pachkowski, J.D.

The Senate Banking Committee held the latest of its hearings examining the future of housing finance in the United States. The subject of the hearing discussed the type of regulator that would oversee the housing finance system and was the seventh hearing held by the committee. The witnesses at the hearing outlined the essential tools needed by the new regulator, as well as important lessons they have learned as regulators of the deposit insurance fund, insurance companies, and the secondary mortgage market.

Currently, the Senate Banking Committee is considering legislation co-sponsored by Sen. Bob Corker (R-Tenn) and Sen. Mark Warner (D-Va), S. 1217, the “Housing Finance Reform and Taxpayer Protection Act.” The Corker-Warner bill would overhaul the mortgage-backed securities markets and reform the government-sponsored enterprises. Among other things, the legislation would require that private market participants hold 10 percent of the first loss of any mortgage-backed security that purchases a government reinsurance wrap and dissolve Fannie Mae and Freddie Mac (GSEs) within five years of enactment of the legislation.

Another provision of the bill would create the Federal Mortgage Insurance Corporation (FMIC) as an independent federal agency to capitalize the housing finance system by separating credit risk from interest rate risk and bringing in private capital to take on both.

Legislation currently pending in the House of Representatives, H.R. 2767, the Protecting American Taxpayers and Homeowners Act of 2013 or PATH Act was approved by the House Financial Services Committee late July 2013. The PATH Act would also terminate the GSEs and create a statutory framework for regulating financial instruments known as covered bonds which are full-recourse debt obligations that are secured by a pool of performing assets. Finally, the PATH Act would establish a National Mortgage Market Utility which would operate a securitization platform that was created by the GSEs. The PATH Act would retain the Federal Housing Finance Agency as a regulator.

Wear many hats. In his opening statement, Committee Chairman, Sen. Tim Johnson (D-SD) noted that FMIC “would wear many hats, as the operator of the insurance fund, the regulator of the Home Loan Banks, mutual organization, and Common Securitization Platform, and authorizer of issuers, servicers and guarantors with regard to guaranteed mortgages.” He added, given the complexity of the housing finance system with its wide range of market participants, “it is critical that we have a strong, effective regulator” and any piece of legislation will need to clearly detail the structure, functions, and powers of the new regulator.

Appropriate balance. The Committee’s Ranking Member, Sen. Mike Crapo (R-Idaho) posed three questions in his opening statement. “When considering reform we must address three pivotal issues about the new regulator: First, how can it appropriately balance its dual role as a regulator and a reinsurer in a highly complex market with diverse stakeholders? Second, what authorities and powers should be vested in the new agency to ensure it is effective without duplicating existing efforts? Third, how should we structure the governing board so that the agency is well equipped to carry out its responsibilities on day one?” Crapo added, “Adopting these principles is crucial because the agency will be tested immediately upon it creation.”

Careful thought and planning. In his written testimony, Alfred M. Pollard, the FHFA’s General Counsel first outlined the functions of the FHFA and noted that it had accomplished the mission Congress has set for it. He then discussed the regulatory structure of S. 1217 and noted that “Implementation of the bill’s varied elements will require careful thought and planning over the five-year transitional period and the undertaking of appropriate transitional steps.” Pollard added that FIMC will need a full array of supervisory and enforcement authorities with regard to the market participants and any implied authority granted to FIMC should be made explicit. To improve the regulatory structure, Pollard suggested that FMIC and FHFA roles in the Financial Stability Oversight Council should be clarified to ensure that during market transition appropriate representation remains in place. He also called for filling of any gaps. For instance, assigning regulatory oversight to FMIC with the ability to set and enforce prudential requirements for non-bank servicers would be one such measure. He also saw challenges in the funding of FMIC if the legislation only calls for fees as a funding base.

Clear statutory authority. Diane Ellis, Director of the Division of Insurance and Research at the Federal Deposit Insurance Corporation provided insight on how elements of the deposit insurance system and the tools employed by the FDIC could be could be adapted for the housing finance system. She noted the existence of clear statutory authority has served as the foundation of the FDIC’s supervisory approaches and have been critical to the FDIC’s resolution activities. In developing an effective insurance program, Ellis noted that there must be a variety of tools to identify and manage risk exposure, not only at the time when insurance is granted but also while that insurance stays in force. She added that strong capital requirements are one of the most effective means for controlling risk-taking by participants and that the Committee “may want to consider inclusion of explicit capital standards for all significant participants in the new system and the consequences of breaching those standards.” Finally, she discussed the need for appropriate pricing of insurance and adequate funding arrangements.

Avoid overreliance on PMI. Kurt Regner, Assistant Director, Arizona Department of Insurance testified on behalf of the National Association of Insurance Commissioners (NAIC) and provided an overview of private mortgage insurance (PMI), noting that NAIC has not taken a position on any of these legislative proposals, including S. 1217. He cautioned against “solutions that solely or substantially rely on the use of private mortgage insurers and financial guarantors as the lubricant for the housing market engine.” He added that private mortgage insurers also have little experience with insuring mortgage-backed securities and that there are regulatory concerns with private mortgage insurers expanding into that business as they could in some cases take on risks in the same loan or type of loan as both a guarantor of the securities and the insurer of the individual loan.

Safety and soundness supervision. In his testimony, Bart Dzivi, Chief Executive Officer of the The Dzivi Law Firm, P.C. called upon the Committee to “analyze both what was good about Fannie and Freddie for American homeowners, and what was bad about Fannie and Freddie for American taxpayers” and urged the committee to “continue its thoughtful and deliberate approach” since “[f]inding the right solution is more important than getting a quick solution.” Dzivi then discussed what is the appropriate level of safety and soundness supervision of the various private entities, such as the mortgage originators, mortgage servicers, and private mortgage insurers, that will be in business with the FMIC. He noted that “[g]iven that a federal credit guarantee is involved, it is critical that any supervision of the private entities participating in the securitization be in the hands of a strong, independent federal regulator.” Dzivi suggested that the powers of the FIMC be patterned after the powers that the federal bank regulatory agencies have at their disposal, such as enforcement actions.

“Mission Control”. Finally, Robert Couch, Counsel at Bradley Arant Boult Cummings, LLP, testified on behalf of the Bipartisan Policy Center Housing Commission. He noted that the new housing finance system outlined in S. 1217 will only work with a strong regulator at the system’s center. This regulator will function as “Mission Control” for the new system and will be charged with fulfilling two responsibilities that are admittedly in tension: promoting a widely accessible mortgage market, while protecting the wallets of the American taxpayers. Couch also highlighted five areas where the Committee could strengthen FMIC’s role in the new housing finance system while promoting mortgage liquidity. He first suggested that the new housing finance system should be patterned after Government National Mortgage Association—Ginnie Mae—which allows for a greater number of financial institutions to be issuers of mortgage-backed securities. There should also be a common securitization shelf for single-family mortgages in order to ensure the system’s liquidity and proper interaction with the To-Be-Announced market. In addition, the system’s regulator should have the authority to temporarily take over the business of issuers, servicers, and/or private credit enhancers that happen to fail and to transfer that business to other private participants in the mortgage system. The fourth area is to provide the regulator with authority to price and absorb first-loss credit risk for limited periods during times of severe economic stress in order to ensure the continued flow of mortgage credit. Finally, dispense with the wind down of Fannie Mae and Freddie Mac and provide a five to 10 year transition period so as to allow for sufficient flexibility and adjustments as private capital plays a larger role in bearing credit risk.

Attorneys: Bradley Arant Boult Cummings, LLP; The Dzivi Law Firm, P.C

Companies: Bipartisan Policy Center Housing Commission; Fannie Mae; Freddie Mac; Ginnie Mae; Government National Mortgage Association; National Association of Insurance Commissioners

MainStory: TopStory FinancialStability GovernmentSponsoredEnterprises Loans Mortgages

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