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From Securities Regulation Daily, July 18, 2013

House panel conducts hearing on legislation to reform securitized mortgage market

By Jim Hamilton, J.D., LL.M.

The House Financial Services Committee held hearings on legislation that would reform the mortgage securitization process in the U.S. The Protecting American Taxpayers and Homeowners (PATH) Act of 2013 is designed to protect American taxpayers and homeowners by creating a sustainable housing finance system for the 21st century. A Committee staff memorandum indicated that the PATH Act is designed to be a comprehensive proposal to create a sustainable housing finance system by ending the federal government’s domination of the housing finance market and giving consumers more choices in determining which mortgage product best suits their needs.

Among other things, the Act would exempt issuers of asset-backed securities from the proposed definition of “Covered Funds,” which is the list of private investment funds and vehicles in which banks are restricted from investing. The sponsors reasoned that adopting a broad definition for Covered Funds to include asset-backed securities issuers would render impossible many beneficial types of securitization for banks. The bill would also ensure that the SEC’s implementation of its Regulation AB, which imposes requirements for the registration, disclosure, and reporting of all publicly registered asset-backed securities, including mortgage-backed securities, does not negatively impact ABS issuances.

The Act also directs the Secretary of the Treasury, in consultation with other relevant federal financial regulators, to establish a covered bond regulatory oversight program. The Act clarifies that covered bonds are securities but not asset-backed securities.

Opening remarks. In his opening remarks, FSC Chairman Jeb Hensarling also noted that the PATH Act ends the bailout of Fannie Mae and Freddie Mac by gradually winding them down over a five-year transition period. The PATH Act also protects taxpayers and homeowners by finally codifying what most everyone claims the FHA was designed to do; that is, an agency that was intended to help first-time homebuyers and those with low and moderate incomes. The PATH Act also tears down barriers to private capital and frees homebuyers from a government-dominated system, said Chairman Hensarling, adding that reforms in the PATH Act increase competition, enhance transparency, and give consumers more freedom to choose the mortgages that are right for them as long as the terms are fully disclosed and understandable.

Concomitant with the hearing, Financial Services Committee Ranking Member Maxine Waters (D-Cal.) released a set of critical core principles, which Committee Democrats believe should be part of legislative efforts to address the future of housing finance reform. The principles include such items as maintaining the 30-year fixed rate mortgage, providing stability and liquidity, and requiring transparency and standardization.

Holtz-Eakin testimony. Douglas Holtz-Eakin, former Director of the Congressional Budget Office, testified that the most significant component of the legislation is its commitment to winding down and closing Fannie Mae and Freddie Mac. These government-sponsored enterprises are fundamentally flawed in their design and politically toxic, he noted. The legislation builds upon the foundation of the Federal Credit Reform Act to require fair value accounting in identifying the financial condition of government-related housing finance. Mr. Holtz-Eakin described this as an important step in the right direction. He noted that fair value accounting has already been used successfully as the budgetary treatment of the Temporary Asset Relief Program of 2008 (TARP) and the federal assistance to Fannie Mae and Freddie Mac.

Zandi testimony. Mark Zandi, Chief Economist of Moody’s Analytics, testified that the PATH Act contains a comprehensive but ultimately unviable proposal to wind down Fannie Mae and Freddie Mac and privatize the nation’s housing finance system. If fully implemented, the PATH Act would lead to significantly higher mortgage rates, particularly in tough economic times, and would put 30-year fixed rate mortgage loans out of reach for most Americans. The legislation encourages development of the private mortgage market by establishing a securitization platform that would be a non-government, non-profit utility open to all mortgage security issuers.

Like the common securitization platform that the FHA, Fannie, and Freddie are currently working on, the PATH platform would help set standards for mortgage origination, servicing, pooling and securitization. The PATH Act also provides a legislative and regulatory framework for covered bonds, another financing mechanism currently used mostly by large European banks. Various parts of the Dodd-Frank Act financial regulatory reform and Basel III international banking standards would also be either repealed or delayed, with the goal of encouraging more private mortgage lending.

According to Mr. Zandi, complete privatization of the securitized mortgage market is much more plausible in theory than it would be in practice. Private capital is not limitless, and there are plausible catastrophic scenarios, similar to the Great Recession, that would completely wipe it out. At that point, the government would have little choice but to intervene, or the system would collapse. Regardless of what policymakers say, global investors will almost surely continue to believe the U.S government would step in if housing foundered. This was amply demonstrated in the financial panic when the government rescued Fannie and Freddie, after saying for years that it would not do so. After Congress’ approval of the Troubled Asset Relief Program (TARP) and the bank bailouts, investors believe Washington will inevitably act if the broader financial system is in danger.

Mr. Zandi warned that the potential advantages of privatization would also be overwhelmed by disadvantages in the form of much higher mortgage rates and a much less stable source of mortgage funding across the economy’s ups and downs. The 30-year fixed-rate mortgage, the bedrock of mortgage lending since the Great Depression, would also be significantly diminished.

Wallison testimony. Peter Wallison, Arthur F. Burns Fellow in Financial Policy Studies at the American Enterprise Institute, testified that the draft legislation is following the views of former Fed chair Paul Volcker, who said in 2011 that the mortgage market in the United States is dominated by a few government agencies or quasi-government organizations and the need for reform is self-evident and the direction of change is clear. Mr. Volcker said that Congress should not countenance a residential mortgage market, the largest part of the capital market, dominated by government-sponsored enterprises. The residential mortgage market today remains almost completely dependent on government support, noted Mr. Volcker, and it will be a matter of years before a healthy, privately supported market can be developed. But it is important that planning proceed now on the assumption that government-sponsored enterprises will no longer be a part of the structure of the market.

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