Potential Problems with Privatization

In the past two weeks, senior republicans in the House and Senate have introduced comprehensive legislation to reform the nation’s housing finance system.  On October 31, House Committee on Financial Services’ member Scott Garrett (R-NJ) released proposed legislation to replace the current government-sponsored enterprise (GSE) model with a private mortgage-backed securities (MBS) market established under a regulatory framework based on a clear-cut, risk-based pricing system and without a government guarantee.  On November 9, Senate Banking, Housing and Urban Affairs Senior Senator Bob Corker (R-TN) introduced the Residential Mortgage Market Privatization and Standardization Act (S.1834), legislation to unwind the GSEs Fannie Mae and Freddie Mac and replace them with a private, forward-funded MBS market based on certain deliverability rules and technology established by the Federal Housing Finance Agency and banks, servicers, originators, GSEs, and mortgage investors.

While both bills are intended to reform and replace the current GSE MBS mortgage-finance model, only Senator Corker’s bill includes provisions to wind-down Fannie Mae and Freddie Mac.  The primary reason Representative Garrett’s proposal lacks “wind-down” provisions is the fact that the House Financial Services Committee has already passed 15 bills to wind-down different aspects of Fannie Mae and Freddie Mac’s current business that Representative Garrett, in his legislation, assumes to have been enacted.  The Democrat-controlled Senate Banking Committee has yet to mark up legislation that would impose a piecemeal or comprehensive measure to wind-down and overhaul the GSEs; Senator Corker’s legislation reflects that fact.

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A discussion draft of the legislation was introduced October 31, 2011 by Senior House Financial Services Committee member Scott Garrett (R-NJ). Here is a summary of the key points:

• Requires the Federal Housing Finance Agency (FHFA) to establish classifications for mortgages-backed securities (MBS) – to be known as Qualified Securities (QS) – and set standards around key features of the securities in order for investors to appropriately price credit risk into the QS market. Further requires FHFA to establish criteria for each classification based on underwriting, pooling and servicing, and disclosures’ standards.

• Authorizes the FHFA director to establish standards of classification for the mortgages that collateralize QS based on a mortgagors’ debt-to-income ratio, loan-to-value ratio, credit history, loan documentation, occupancy, credit enhancement, and loan payment terms.

• Directs the FHFA to establish standard form securitization agreements for QS that include terms relating to: pooling and servicing; purchase and sale; representations and warranties; indemnification and remedies; and the qualifications, responsibilities, and duties of trustees.

• Establishes an application system for qualified sponsors of QS under which interested parties would submit applications to the FHFA demonstrating proof of their experience and integrity, compliance history with Federal and State laws, adequacy of insurance and fidelity coverage, and ability to regularly submit audited financial statements to the Agency.

• Grants the FHFA director broad supervisory and enforcement capabilities, with the authority to issue regulations, orders, and interpretations in order to establish a fully-liquid forward market for QS – similar to the Fannie Mae and Ginnie Mae to-be-announced (TBA) markets in which most agency mortgage-backed securities are sold today.

• Directs the FHFA to establish mandatory arbitration procedures under which all disputes between an owner of a QS and the qualified sponsor of such QS shall be subject in the event of a disagreement between investors and issuers on whether there was a breach obligating an originator or securitization sponsor to repurchase a loan or to indemnify a loss.

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The Senate Banking Committee on October 20 held a hearing to discuss the possibility of, and the need for, the continuation of the 30-year fixed-rate mortgage as the primary financial structure to back the future U.S. housing finance market.

Committee Chairman Tim Johnson (D-SD) began the hearing with a statement in which he explained that a full overhaul of the nation’s housing finance system will not occur in the near future. Specifically, Senator Johnson said he expected the Committee’s schedule and work-flow will prevent it from introducing a comprehensive piece of housing finance legislation for at least a year.

The panel of witnesses at the hearing included industry stakeholder and President and CEO of  Affinity Federal Credit Union John Fenton, testifying on behalf of the National Association of Federal Credit Unions;  housing policy expert and Senior Policy Analyst at the National Council of La Raza Janis Bowdler; Professor of Finance at the George Mason School of Management Dr. Anthony Sanders; and economic policy gurus Dr. Paul Willen, Senior Economist and Policy Advisor at the Federal Reserve Bank of Boston, and Dr. Susan Woodward, President of Sand Hill Econometrics.

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Prospects for Increased Program Participation

On October 24, the Federal Housing Finance Agency (FHFA) announced that it will modify a number of borrower eligibility and lender participation requirements of Home Affordable Refinance Program (HARP) in an attempt to increase participation in the federal refinancing program.

photo courtesy of kevin dooley

HARP was implemented in 2009 in order to allow underwater homeowners the opportunity to refinance their home loans to lower mortgage interest rates. Many borrowers were eager to take advantage of the historically low rates, but were handicapped by their inability to meet some of the standards typically required to refinance, such as those that preclude borrowers with high loan-to-value loans. HARP was modeled – like several other Administration loss mitigation and foreclosure prevention programs started around the same time – to assist a very specific problem and class of homeowner. In HARP’s case, the target homeowner is one who wished to refinance his or her mortgage, but owes more on their mortgages than their individual homes are worth. Program administrators believed that underwater homeowners represented a substantial portion of the troubled homeowner populations, and that HARP would go a long way to stymie the accelerating wave of foreclosures flooding the nation’s housing market.

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