This article appears in shorter form in the January 2011 ABA Banking Journal. ABA weighed in on the pending mortgage debate in a Feb. 9 letter from President Frank Keating. The letter, issued in anticipation of release of the Administration's housing finance proposals, outlined ABA positions in this area. To read the letter, click here. On Feb. 11, the Obama Administration, through the Treasury Department and the Department of Housing and Urban Development, released its much-awaited plan, referred to in the article below. You can access the report here , or read an official summary here .
ABA’s top legislative strategists believe that a key post-crisis set of issues, not dealt with in Dodd-Frank—the future of Fannie Mae and Freddie Mac, and the shape and character of U.S. housing finance in years ahead—will be addressed not in a single piece of legislation, but several.
While that goes on, the banking lobby will be working in both the legislative and regulatory branches on Dodd-Frank’s implementation, and oversight of same. All this will occur against a backdrop of a House now under Republican control, a Senate with new key leaders and a higher percentage of Republicans (see companion article, p. 30), and with a significant new regulator: the Consumer Financial Protection Bureau.
Mortgage reform to the fore
“The Dodd-Frank Act affects everything you can imagine, but the impetus for much of it was the mortgage lending crisis,” says ABA’s Bob Davis. “More of Dodd-Frank deals with mortgage lending than anything else. The regulators have more rules and regulations pending in the mortgage area than any other, and it will be the primary focus of the consumer bureau as well.” Davis is ABA executive vice-president for mortgage finance, risk management, and public policy.
Where is Dodd-Frank heading?
“Politically, the role of Fannie Mae and Freddie Mac is not as high today, but it is still very, very big,” says Stoner. “People in Congress have strong views about what to do. And none of that is going away, even though the sense of crisis may have diminished.”
While urgency remains, ABA’s experts, interviewed in late December, see a change of tone.
“As Dodd-Frank evolved, bankers recognized that there were elements of the law that are killers,” says Wayne Abernathy, executive vice-president, financial institutions policy and regulatory affairs. “That’s still the case and if they aren’t changed they will kill a large number of banks over time. That’s what made the Dodd-Frank discussions so bitter.”
Abernathy says there’s been a thawing between ABA and the Obama Administration and the Treasury Department. “There’s been a clear effort to reach out more to the banking industry,” Abernathy explains. “This is a dialog we wished we could have had over the course of the last year. Then, it was episodic, at best. But this seems like a determined effort to engage.”
Says Abernathy: “That’s positive for our industry and our customers.”
Fannie and Freddie entered conservatorship in September 2008. Their future is intimately tied up with many diverse issues. These include the future roles of the public and private sector in home lending; the government’s role in guaranteeing mortgage investments; the funding of mortgage borrowing and the roles of on-balance-sheet and off-balance-sheet lenders; the role of banks as investors in mortgage securities; and the competitive positions of large and small depository institutions as the mortgage and deposit markets eventually return to some degree of normality.
In other words, a huge Gordian knot.
“It’s very difficult to imagine a sweeping single bill that gets all of it right,” says Davis. “It’s hard to imagine a sweeping bill that gets most of it right. So that’s why an incremental approach may be the answer.”
Deliberate, gradual, piecemeal moves may be how it goes, rather than any “magic bullet,” Davis suggests. He says ABA believes it’s critical that Washington find the means to move the two giants through their conservatorships; evolve the system towards its new form; remove much of the federal support for the mortgage market; and set up private-sector replacements to meet America’s housing credit needs.
That’s a big gulp.
“Very interestingly,” Davis continues, “the Treasury Department has begun to speak in terms not about a plan that can be implemented in some sweeping way, but a ‘path.’ We think they’re talking about a path that we want to follow.”
Historically, Treasury Departments labor to produce huge blueprints of “the world according to us.” Some never emerge from the land of the wonks. This anticipated difference in approach is notable.
“Congress is going to chew on this,” says Stoner. “It is probably going to chew on this for two years.”
“That’s not a bad thing,” suggests Abernathy. “You want to make sure that whatever you do makes a lot of sense.” Stoner points out that tinkering with mortgage finance will have an impact on the nation’s economy at a critical political juncture. “The goal of the Administration appears to be moving towards a singular focus on making sure the economy recovers, certainly within two years,” Stoner says. “And laying a heavy dose of major change on the housing markets doesn’t help you do that.”
Davis acknowledges that the issues are so diverse and broad, a single congressional vote up or down can’t resolve matters.
“They’ll take small bites along the way,” he suggests. To a degree, this plays into the avowed strategy of John Boehner (R.-Ohio), new Speaker of the House. He has suggested his chamber will pass many targeted bills, rather than broad ones. Davis calls it a “Lego block” strategy, passing the pieces of what the industry wants to see assembled.
One such issue is the two government sponsored entities’ existing mortgage portfolios. Davis suggests the government could set about liquidating those holdings over time, removing them from the process.
“There isn’t support on either side of the aisle for the historical structure at Fannie Mae and Freddie Mac,” says Davis. “But they still are most of the market. In fact, they are more of the market than they ever were, now that they are owned by the government.”
Davis has thought of a literary analogy for this situation: “Right now,” he says, “you can think of Fannie-Freddie as the Cheshire Cat, pretty much occupying the whole space. The path I’ve been talking about will probably be designed to shrink the Cheshire Cat—but maybe we’ll keep the smile.”
Changing government’s role
ABA believes the Administration and some members of Congress have sympathies for a significant change in the government’s role in housing credit.
The mortgage market—somewhat by design, tradition, and as a result of recent circumstances—consists of many threads. Unwinding them won’t be simple.
Currently, the ABA analysts point out, the Federal Housing Administration plays a larger than typical role in home finance, and Fannie and Freddie have most everything else. Private-label securitization, at present, is a small factor.
What ABA and other players hope for is a systematic evolution. Under a Dodd-Frank mandate, the Administration must unveil proposals at the end of January.
“As Fannie and Freddie shrink away, you have to fill the gap,” Davis explains. “The capacity to make mortgages and hold them in portfolio will always be limited by the capital of banks. You are never going to be able to keep all of the mortgage credit that this country needs on leveraged lenders’ balance sheets.”
An ABA priority, in the coming debate, is protecting the Federal Home Loan Bank System. Analysts see it as growing in importance as deposit insurance pricing changes wrought under Dodd-Frank create greater large-bank competition for incentives for deposit funding.
Not even easy on paper
Shifting from a securitization market dominated by the GSEs to one substantially operated and owned by private parties presents many challenges.
Pricing of risk at a realistic level represents only one such challenge.
To date, federal involvement has skewed the pricing of risk, according to Abernathy. Extensive federal guarantees, over time, “masked the ability of people to recognize and manage the underlying risks in mortgages,” he says. “If there’s any lesson we should have learned from the most recent financial decline, it’s that those risks have a way of manifesting themselves, eventually.”
The future American mortgage
Contrary to many Americans’ warm feelings, the 30-year fixed-rate mortgage was not mentioned in the Constitution. Will it survive the journey from today’s market to the future?
“The market will determine that,” says Davis. “I think there are lenders that might offer them.”
Addressing risk issues may keep the option open. Interest rate risk dominates the picture, while credit risk plays a strong secondary role.
“The credit risk occurs because homeowners with a 30-year mortgage take a long time to build up equity, through the amortization process,” says Davis. “Home prices may go up, but we now know that they also go down.” The current spate of “walkaways” underscores this.
Abernathy believes the private sector can manage such risks. However, building up this capability hinges first on realistic government pricing, and, eventually, limiting federal participation.
“If the private sector has to compete with government, then the risks become distorted,” Abernathy explains. “It becomes hard to value exposures. So it will be important to figure out, relatively early, what the future role of the government will be.”
Bottom line: Private-sector participation won’t pick up until investors have to pay up, and thus have an incentive to seek private-sector alternatives, says Davis. Right now, he adds, the federal safety net for mortgages costs all of 25 basis points.
Davis says the future of mortgage finance hinges as well on other aspects of the underlying mortgage instruments, and they are already evolving.
“What will those loans look like?” asks Davis, rhetorically. “They will all be documented loans. They will all be based on ability to pay. After April 1, 2011, they will be originated by people who cannot be paid additional amounts on yield spread premiums for pushing people into loans paying higher rates.”
Over time, these shifts could contribute to an industry structure where more than half the nation’s mortgages could be originated and securitized with no government involvement at all, Davis suggests.
“That’s not going to happen this year, and it won’t exist next year,” he says. “But it’s something we can walk a path towards.”
Servicing issue develops
Another factor feeding into the debate will be the ongoing residential foreclosure issue, in all of its stripes.
“There’s recognition that the servicing business was set up primarily to efficiently collect money in good times from borrowers, to pass it along to the ultimate investors,” says Davis. “Servicers did a good job of that. But they weren’t set up, in terms of staffing and training, to handle the avalanche of modifications and foreclosures.”
Will this issue drive its own facet of mortgage reform? Davis says there has been talk about national standards for mortgage servicers, as well as nationalization of the foreclosure process. The latter he doubts will make it: “Property law is state law, and I don’t think there’s going to be a big override of state law.”
However, Davis says national servicing standards are “a distinct possibility. How that would be done will unfold over the course of 2011.” Davis says federal regulators have been exploring action under existing laws.
“Smaller lenders have a strong interest in seeing this resolved, as well,” says Davis. One reason: problems for large servicers will create logjams in the system for all players. Another: Smaller lenders making home equity loans frequently have junior liens on properties secured by large servicers’ first mortgages.
“There are lots of points of tangency in the system between large lenders and small lenders,” says Davis. “So there’s broad interest in getting this worked out.”
Near-term fixes loom
As Davis noted earlier, much in Dodd-Frank relates to mortgage lending. One of the first products of the Act, expected to be proposed in January, is the Dodd-Frank risk-retention regulation—the “skin in the game” rule.
Davis points out this will affect both originators and securitizers, and much will depend on what the new rules look like.
Abernathy worries about the cumulative effect of these and other shifts in mortgage regulation.
“We don’t feel it right now,” he says, “because people aren’t buying a lot of houses. But as demand begins to increase, the insecurity of the new rules could put new strains on the economy.” ·