Toward a New Secondary Mortgage Market
MichaelBrightandEdDeMarco
September2016
Executive Summary
Thereisasimpleandsensiblewaytofinallyachievecomprehensivehousingfinancereforminour
country.TheapproachweproposeinthispaperistoamendthechartersofGinnieMae,FannieMae
andFreddieMac,andtheFederalHousingFinanceAgency(FHFA).
Simplyamendingthesecharterscanaccomplishawideswathoftheobjectivesthathaveeluded
legislatorsandpolicymakerssincetheconservatorshipofFannieMaeandFreddieMacbeganin2008.
Eachofthecharterchangesweproposecanstandonitsownrightassoundpolicy.Collectively,they
allowustotakeimportantstepstowardamorerobust,dynamic,andsecuremarketformortgagecredit
risk.
Allofthiscanbeachievedwhilenotmateriallyaffectingborrowerinterestrates,sinceweleveragea
well-knownandwidelyacceptedgovernment-backedsecuritythatthemarketalreadyunderstands,as
wellasrisktransfermechanismsthatthemarkethasacceptedsince2013.Thetransitiontothisreform
canbeaccomplishedsmoothly,leavingahousingsystemthatisefficient,opentocompetitionand
innovation,andensuresastablesupplyofmortgagefinancing.
Ourproposalwouldendtheconservatorships,reconstituteFannieMaeandFreddieMacaslenderownedmutuals,andbuildonthecreditrisktransfer(CRT)initiativetocreateaprivatemarketfor
mortgagecreditriskwhilepreservingagovernment-guaranteedratesmarketformortgage-backed
securities.OtherfirmscouldcompetewithFannieandFreddieinthebusinessofaggregatingloansand
gatheringtogethertheprivatecapitalthattakesonhousingriskaheadofthebackstopgovernment
guarantee.Weseektomakethesechangeswhilepreservingasmuchaspossiblehowlenders,servicers,
andothersoperatetodaysoastokeepwhatworks,avoiddisruptiontocurrentbusinesspractices,and
limitriskintransition.
1
Theframeworkoutlinedinthispaperfeaturesthefollowingkeyprovisions:
FannieMaeandFreddieMac
! Passedthroughreceivershipandreconstitutedasentitiesmutuallyownedbytheirsellerservicers.
! Havetwoprincipalbusinessfunctionsinthesingle-familymortgagemarket:
! Providecreditenhancement.Astheyhavebeenforthepastfewyears,thecompanies
wouldsyndicatemortgagecreditriskthroughavarietyofcreditrisktransferstructures,
therebycontributingtoabroadanddeepmarketformortgagecreditriskthatdisperses,
ratherthanconcentrates,riskandensuresongoingmarketanalysisofcreditrisk.
! Maintainacashwindowforsmallandmid-sizedlenderstosellmortgagesforcashand
aggregatetheseloansforsecuritizationandcreditrisksyndication.
! Nolongerhavetheattributesoftheiroldgovernment-sponsoredenterprise(GSE)charters,nor
wouldtheymaintainaninvestmentportfoliooroperateinaprotectedduopoly.
GinnieMae
! TakenoutoftheDepartmentofHousingandUrbanDevelopment(HUD)andmadeastandalonegovernmentcorporationliketheFDIC,withauthorityoveritsownbudget,hiring,and
compensation.
! Authorizedtoacceptprivate-sectorcreditenhancementfromentitieslicensedbytheFHFA.
! Provideafull-faith-and-creditwraponmortgage-backedsecurities(MBS)issuedbyGinnieMaeapprovedissuerswheretheloanpoolsarecredit-enhancedeitherbyagovernmentprogram
(suchasFHAorVA)orbyFHFA-approvedcreditenhancersthatarrangefortherequired
amountsofprivatecapitaltotakeonhousingcreditriskaheadofthegovernmentguarantee.
FHFA
! Continuestoregulatethehousingfinancesystem,includingsecuritizationandthequantityand
qualityofprivatecapitalstandinginfrontofthegovernmentguarantee,asnotedbelow.
! Overseesthewindingdownoftheconservatorships,includingoversightoftheoutstanding
FannieandFreddiesecuritiesbackedbytheTreasurysupportagreements.
! Authorizedtosetstandardsforprivatecreditenhancementofloanpoolsandwouldlicenseand
examineentitiesprovidingsuchcreditenhancement.
! Ensuresstandardizationacrossthehousingfinanceecosystemwithregardtodata,data
reporting,etc.toensureatransparentandliquidmarket.
! EstablishesandoperatesaMortgageInsuranceFund(MIF)fundedbyindustryassessmentsto
backstopthecreditenhancementmarket.
Introduction
Housingmattersforsomanyreasons—economicones,yes,butalsobecauseitisabasichumanneed,
theplacewherefamiliesandlivesarebuilt.AndhousingformostpeopleinAmericaisthemost
expensiveitemintheirmonthlybudget,whethertheyrentorown.Therefore,howhousingis
financed—oreveniffinancingisavailable—isofcriticalimportancetoeveryone.Fromthestandpointof
theoveralleconomy,investmentinhousingandconsumptionofassociatedproductsandservices
representakeycontributortoGDP.Forfinancialmarkets,problemsinthehousingfinancesystemwere
atthecenteroftherecentfinancialcrisis.Gettingthisrightmatters.
2
Thehousingfinancesystemandwhateverchangeswemaketoitmustensuretheongoingavailabilityof
credittosupportthemanagementofrentalhousingandthefinancingofhomepurchasesforthose
readytotakethatstep.
TheU.S.housingmarketwasattheepicenterofthe2008globalfinancialcrisis,ofcourse.Andsince
thenCongresshasallocatedhundredsofbillionsofdollarstokeepthesecondarymortgagemarket
solvent.Yettheemergencyandsupposedlytemporarystateofgovernmentownershipofone-fifthof
theeconomy1hasyettobeaddressedbyCongress.
Theimportanceofhousingtooureconomyhascontributedtothechallengesofmarketstructure
reform.Theinfrastructureprovidingfinancetosupporthousingshowedfundamentalflawsduringthe
financialcrisisanditremainsinanunstablestate—conservatorship—eightyearslater.Theconstant
politicizationofhousingfinancehasleftusatapolicyimpassedespitebroadareasofagreementon
whatneedstobedone.
Thisisinlargepartbecausethestructurethatundergirdstoday’shousingfinancemarketiscomplex.
Andso,eightyearsafterthefinancialcrisis,withthegovernmentexplicitlybackingthecreditriskonthe
vastmajorityofmortgagesissued,andtheFederalReserveservingasthelargestholderofagency
mortgage-backedsecurities,theentiresystemreliesheavilyonthepublicsectortofunction.
Inthefirstpaperinourseriesonhousingfinancereform,wemadethecaseforwhyreformisneeded
andsetforthitsobjectives.Aswenoted,thetrickistosolvethepolicyproblemsthatmustbeaddressed
whilebuildingefficientlyoffwhatalreadyworks.
Inthispaper,wewilloutlineadetailedpaththatnavigatessuchacourse.Thisstructurewouldreplace
thefailedduopolisticGSEsystemwithoneofcompetitiveprivateinsurers,avibrantmarketfor
mortgagecreditrisk,ownershipstructuresthatrequirelenderstohavesomeskininthegame,and
appropriategovernmentstandard-settingandoversighttoensureadeepandliquidMBSmarket.
Since2008,severallegislativeattemptshavebeenmadetoendtheconservatorshipsoftheGSEs—
FannieMaeandFreddieMac.Mostofthesebillsweregenerallydesignedtousherinamarket-based
systemwhileprovidingautilityandregulatoryroleforthegovernmentinensuringequitableaccessto
thesystemforasmanyAmericansaspossible.Suchproposalsalsohavegenerallyallowedthe
governmenttoprovideatransparentcatastrophicbackstop,thusminimizingtheneedforemergency
congressionalactionduringacrisisandallowingthegovernmenttochargeupfrontforthetailriskthat
manyunderstanditalreadyowns.
MuchoftheDNAofthesepastbillsremainsinwhatwepropose.Butweaimtoachievetheseobjectives
oflegislationviaamorestreamlinedpath.
1
Examplesofthefederalgovernment’sownershipordirectsupportofthehousingfinancesystemincludetaxpayers’direct
supportoftheFederalHousingAdministration(FHA),theTreasurysupportagreementsbackstoppingFannieMaeandFreddie
Mac,theHomeAffordableModificationProgram(HAMP),andtheFederalReserve’snearly$2trillionportfolioofmortgagebackedsecurities.
3
Perhapsthemainconcernaroundmostreformproposalshasbeenviability.Themanymovingpartsof
pastproposalshaveledlegislatorsandstakeholderstobecometrappedonasinglequestion:Willthis
work?ThatwasthemainconcernatplayindiscussionsintheSenatein2014,forexample,andit
remainsahallmarkofmostreformdebatestoday.
Tohelpmitigatethisconcern,wetakeasastartingpointthatreformmustsufficientlyleveragethe
aspectsofourhousingsystemthatweknowalreadyfunctionwell.Butitmustdothiswhiletakingsteps
towardamodelthatridsusofthepre-crisissystemthatallowedprofitstoprivateGSEshareholdersin
goodtimesbutrequiredanemergencytaxpayerbailoutduringatimeofextremestress.Wealsoneed
tomovepastasystemthatleansentirelyonasingleregulatoryagencyinWashingtontomake
underwritingandmortgagepricingdecisionswhileaskingtaxpayerstoshouldermostoftherisk.
Ourplansolvesthesemultifacetedchallengesbyrelyingheavilyontheexistinginfrastructure,thereby
easingthetransitionandensuringthenewstructurewillhavemuchofthelookandfeeloftheexisting
market.Ourproposalleverageswhatthemarketalreadyknowsandunderstands.
Thereisnoleapoffaithinwhatwepropose.Thereis,instead,asteadywalktowardabettermarket
structure.
Howso?Weproposetosimplyamendthechartersthatformthefoundationofoursecondarymortgage
marketsystem:theGSEcharters,theGinnieMaecharter,andtheFHFAcharter.
Theamendmentsweproposewouldsimultaneouslyimprovethesystemandsolvemanyofthepolicy
problemsofthepaststructure.Theywouldpromotecompetitionformortgagerisk,alignincentives
throughoutthemortgageecosystem,leveltheplayingfieldacrosslargeandsmallloanoriginators,and
ultimatelycouldstimulatecreditavailability.
Policy Challenges We Aim to Solve
Reform,nomatterhowmuchfocusitgivestoensuringsimplicityandasmoothtransition,shouldsolve
afewkeypolicychallenges.Thereisoftenatrade-offbetweenthemagnitudeofwhatcanbesolvedand
theamountofriskintransition—atrade-offwebelieveweoptimizeinoursimpleproposal.Still,one
mustensurethatcertainkeyobjectiveshavebeenmet.
Inourpreviouspaper,weidentifiedthreeaspectsofthesecondarymortgagemarketasitworkstoday
thatshouldbepreserved:
1. AliquidMBSmarket,including:
a. TheTo-Be-Announced(TBA)market
b. Standardizationofmortgagedata,servicingrules,andMBSsecuritystructureand
disclosure
2. Nationwide,uninterruptedaccesstothesecondarymortgagemarket
3. Competingoutletsconnectingtheprimarymarkettothesecondarymarket
Wealsoidentifiedfivebroadobjectivesforreform,citingaspectsofthecurrentsystemthatmustbe
fixedorreplaced:
1. Eliminateemergencybailouts
2. Buildsomedegreeofconsensusonamodernizedaffordabilityandaccessibilityparadigm
4
3. Bringmarketsignals,privatecapital,competition,andinnovationbacktothemarket,butwith
standardsandguardrails
4. Eliminatehiddenorimpliedguaranteesandallvestigesofthecronycapitalismthatcharacterize
FannieandFreddie’scharters
5. Alignincentivesasmuchaspossiblethroughoutthesystem
The Government’s Role in Guaranteeing Mortgage Credit
Beforeproceeding,itisworthtakingamomenttolookatthegovernment’sroleinthemortgagecredit
system.
Thefundamentalquestionofhousingfinancereformistheroleofthegovernment,(i.e.taxpayers),in
bearingmortgagecreditrisk.Consideringthisrolemeansassessingwhetheraccomplishingthe
objectivessetforthaboverequiresthegovernmenttoensureorbackstopinvestorsintheeventof
mortgagedefaults.
Today,thegovernmentdirectlysupportsthemajorityofmortgagecreditriskinthemarketthrough
mortgage-guaranteeprogramssuchasFHAandVAandthroughtaxpayerbackingofFannieMaeand
FreddieMac.Whilevirtuallyallpolicymakersagreethatthisisfartoomuchtaxpayerinvolvement,none
ofthelegislativeproposalsofthepastfewyearshaveadvocatedcompleteeliminationoffederal
support.
Forexample,noneoftheproposalsadvocatedeliminatingtheFHAandVAloan-guaranteeprograms.
Moreover,theCorker-WarnerandJohnson-CrapobillsintheSenatewouldhavereplacedthecurrent
taxpayersupportofFannieMaeandFreddieMacwithanewgovernmentcorporationthatwould
explicitlyprovidecatastrophicinsuranceofMBSintheeventthatprivatecapitalprovedinadequate.The
Housebills,onesponsoredbyRepublicanRep.ScottGarrettofNewJerseyandanotherbyDemocratic
Rep.JohnDelaneyofMarylandandothers,wouldhaveutilizedGinnieMaetoprovidesomelevelof
governmentguarantee,albeiteachinadifferentway,andGarrett’sPATHActonlywhenmarket
conditionswarranted.
Likemanyreformadvocates,weconcludedthatthevastmajorityofmortgagecreditriskinherentinthe
conforming,conventionalmortgagemarket—themarketsegmentservedbyFannieMaeandFreddie
Mac—canandshouldbebornebytheprivatesector.Thereisamplecapitalableandwillingto
underwrite,price,andmanagemortgagecreditriskprovidedthemarketoperateswithtransparency
andclarityregardingtherules,includingtherulessurroundingborrowerdefaults.Hence,thereisa
crucialroleforthegovernmentinestablishingandenforcingsuchrules.
Importantly,webelievetheresidualcreditrisk,sometimescalledthecatastrophicrisk,shouldultimately
betheresponsibilityoftheprivatehousingfinancesectoraswell,withthegovernmentprovidingonly
temporalsupportduringaneconomiccrisissoastosmoothoutlossesthatultimatelyremainthe
market’sresponsibility.Still,agovernmentroleinsomeformisprobablykey.
Wecametothispolicyconclusionforfourreasons:
1. Thecreditrisktransfermarketinitiatedseveralyearsagodemonstratesthecapacityand
interestofmarketparticipantsinthiscreditmarket.Yetfromourexperienceandinteraction
5
withnumerousmarketparticipants,weconcludedthatthevastmajorityofthembelievethe
$10trillionsingle-familymarketisincapableofabsorbingalltheembeddedcreditriskinthis
market,largelybecauseofthedifficultyinpricingandreservingfortheveryinfrequentand
catastrophiccrediteventsinhousing.
2. AgovernmentguaranteeofMBSthatreplacestheFannie-Freddiemarketsegmentwould
cleanlyseparatethemarketformortgagecreditriskfromthefundingmarketformortgages
(knownastheratemarket),whichundertakestheinterestrateriskinmortgagelending.Onlya
governmentbackstopguaranteeperfectlybifurcatesthosemarkets.Removingcreditriskfrom
theratemarketusingagovernmentguaranteehasthesubstantialbenefitofwideningthepool
ofeligibleinvestorsintheratemarket,thusloweringmortgageinterestrates.Withtheprivate
sectorbearingallthecreditandinterestraterisk,thesubsidywouldbesmall,therebyreducing
themarket-distortingeffectsofthecurrentbuilt-insubsidies.
3. SuchaguaranteewouldalsopreservetheTBAmarketasitfunctionstoday,removingakey
elementofuncertaintyinthereformdebate.
4. Acatastrophicguaranteeactsasanautomaticstabilizer,enhancingmarketstabilityandhousing
financeliquidityduringaneconomiccrisis.
Thepre-conservatorshipFannieandFreddiemarketconcentrated$5trillionofmortgagecreditriskon
twobalancesheets—FannieandFreddie’s—whileinvestorsintheirMBSsawthroughtheFannieand
Freddiecorporatecreditguaranteestothetaxpayersstandingbehindthem.Foryears,thiswaswidely
describedastheimplicitguaranteeinherentintheFannie-Freddiemodel.Yetthegovernmentofficially
deniedsuchsupportwouldbegivenandthusneverreceivedcompensationfortheeconomicbenefitit
providedFannieandFreddieshareholders.Therealityofthisimpliedguarantee,however,wasmade
manifestin2008.
Inconservatorship,thetaxpayerguaranteeisexplicitthroughtheTreasurysupportagreementsthat
allowFannieandFreddietocontinuetooperatedespitetheirfailureduringthecrisis.Theexistenceof
thisguaranteehasallowedtheenterprisestocontinuetofunction,andbecauseofittheFederal
ReservehasbeenabletopurchasetheMBSissuedbytheenterprises,inanefforttolowerborrowing
costsforhomeowners.
Butoverthepastfewyears,attheirconservator’sdirection,bothFannieandFreddiehavebegunselling
offmortgagecreditrisktoprivateinvestors,buildingasmallbutgrowingprivate-capitalbufferinfront
ofthetaxpayer.Webelievethesecreditrisktransfertransactionshavebeenimportantstepsinclearing
apathtowardarobustmarketformortgagecreditrisk,whichissomethingourfinancialsystembadly
needs.2
Ourreformproposalcontinuestowardanendstatewithadeepandliquidmarketformortgagecredit
risk.Infact,thehallmarkofourproposalisthecreationofavibrantcreditmarketmanagedbyregulated
credit-enhancemententities,mostofwhichwouldoperateasmortgageguarantorsandreinsurers.
WeproposeestablishingabackstopMortgageInsuranceFundmanagedbythegovernmentasa
catastrophicriskpoolfundedbytheparticipantsin(thatis,beneficiariesof)thehousingfinancesystem.
2
Foradditionalbackgroundonthestepstakentodateandthosestillneededtofullydevelopamarketformortgagecreditrisk,
seeEdwardJ.DeMarco,“(Re-)CreatingaMarketforMortgageCreditRisk,”October28,2015;
http://www.milkeninstitute.org/publications/view/748.
6
FeeswouldbeleviedontheindustrytoprefundtheMIF,andanylateruseoftaxpayermoneytoaddto
thefundwouldberepaidbyindustryassessments.Thisissimilartohowthedepositinsurancefunds
operatedbytheFDICprotectinsureddepositorstoday.
Uptothispoint,ourproposalissimilartonumerouslegislative,industry,andthinktankproposalsthat
havecirculatedinrecentyears.Butitpartswayswithmanyofthembyrelyingonanexistingfederal
corporation—theGovernmentNationalMortgageAssociation(GinnieMae)—ratherthancreatingone
ormorenewfederalentitiestoaccomplishitsgoals.3
GinnieMaeisagovernmentcorporationwithintheDepartmentofHousingandUrbanDevelopment.It
doesexactlywhatwejustdescribed,exceptitdoesitformortgageswhosecreditriskisguaranteedby
FHA,VA,orotherfederalprograms,notbyprivatecapital.WebelievethatusingGinnieMae’splatform
andworld-recognizednameplateasaU.S.governmentbackstopguarantorofMBS,butwithprivate
capitalinfront,providesaneasytransitionthataccomplishesthegoalsdescribedabove.Gettingthere
willrequireamendingGinnie’scharter,thechartersofFannieandFreddie,andtheFHFAcharter,butit
doesnotrequirecreatinganynewfederalprogram,corporation,oragency.Moreover,manyofthe
participantsinthehousingfinancesystemenvisionedinourproposalalreadyexist;thereisnoneedto
relyonentrybyunknownfuturefirms.Suchentryandcompetitionissupported(evenencouraged)in
ourmodel,tothebenefitofbothtaxpayers,throughincreasedsafetyandreducedsystemicrisk,and
futurehomeowners,throughlowermortgagecosts.
Intheremainderofthispaper,weoutlinehowweproposeamendingthesethreesetsofchartersto
createasmoothpathtoanewsecondarymortgagemarketthatallowsaccessforalllendersanda
reliableandstablesupplyofcapitaltofundmortgagesacrossthecountry.
Step One: Amendments to the GSE Charters
Webeginbyasking:Whatistobecomeofthesetwoentities,FannieMaeandFreddieMac,which
currentlyoperateongovernmentlifesupportbutlargelykeeptheconventionalmortgagemarket
functioning?Afterall,thelifesupportwasputinplaceinrecognitionoftheimportanceofnotupsetting
theroughly$5trillionsegmentofthemortgagemarketservedbythesetwoenormousenterprises.
Transitiontoanewsystemmustaccountforthecurrentoperationsofthesetwocompaniesandthe
manylendersandmortgageservicersthatrelyonthem.
Yetwestronglybelievethatanewsystemmustopenthedoortocompetitiveforcesandtoamortgage
marketthatismoreholisticallyresponsiblefortheperformanceoftheloansoriginated.Ensuringthat
lendershadskininthegame(thatis,hadtheirowncapitalatriskintheirlendingdecisions)wasakey
objectiveoftheDodd-Frankfinancialregulatoryreformbill,butithasbeeneffectivelyevisceratedby
3
WearenotthefirstonestoproposeusingGinnieMaeasthecenterpieceofhousingfinancereform.Otherswhohave
proposedacentralroleforGinnieMaeincludetheDelaney-Carney-Himesbill(https://delaney.house.gov/news/pressreleases/delaney-carney-himes-file-housing-finance-reform-legislation-to-protect-30-year);RobertCouchandJoeMurin
(http://www.housingwire.com/articles/14005-former-ginnie-mae-execs-submit-gse-reform-plans);GaryAcosta,JoeMurinand
GaryPark(http://www.urban.org/policy-centers/housing-finance-policy-center/projects/housing-finance-reformincubator/gary-acosta-jim-park-and-joe-murin-future-gses-ginnie-mae-20-solution);andAndyDavidson(https://www.adco.com/analytics_docs/GSERoundtableSummary_2015.pdf).
7
decisionstakenbythevariousregulators.Wechangethis.Achievingthesepolicyobjectivesputsusona
pathtowardamorestablehousingmarket.
Withthesegoalsinmind,wesettoanalyzinghowthecrucialfunctionstheGSEsperformcanbe
preservedwhilethesystemmovestowardsounderfootingthroughreforms.
Tobegin,weproposethatthenewsystempreserveaplacefortheentitiesreconstitutedfromFannie
andFreddiebutthatthereconstitutedentitieslosethespecialprivilegesoftheirGSEcharters(including
theirprotectedstatusasthegatekeepersofallmortgagecreditrisk).Thereconstitutedfirmswould
havetocompeteandsurviveinamarketplaceopentodisruptionandcompetitiveforces.Wealso
believethattheirlendersshouldhaveoversightoftheiroperationsandskininthegametoprotect
againstlosses.
Inthissection,weoutlinethecharterchangesthatwouldallowFannieandFreddietocontinue
performingmanyofthebusinessfunctionstheyhaveperformedfordecades,butwithoutmanyofthe
specialprivilegesthattookthemoffcourse.Wealsoseektoeliminatetheconflictingmandatestoserve
shareholdersaspubliclytradedcompanies,servelendersastheonlytwooutletsforsecuritization,and
servethepublicinterestthroughtheircongressionalcharters.
TheGSEs,inourview,shouldbecomecreditrisksyndicatorsthattakeoncreditriskfromtheirlenders,
sellittoinvestorsthroughcreditrisktransfer,andhelpdrivethemarkettoinnovateandevolve.And
thelendersthatutilizetheseenterprisesshouldhaveastakeintheirmanagementandperformance.
AndwebelievethatnomatterwhatwedowithFannieandFreddie,theyshouldNOTbetheentire
marketformortgagecreditriskinthiscountry.Theyshouldoperateinacompetitivemarketplace.And,
ofcourse,theywillneedcapitalbeyondCRTtooperatesafely.
Gettingthereinvolves,one,changingFannieandFreddie’sownershipstructure;two,requiringtheuse
ofrisktransfer;andthree,leveraginganalready-builtgovernmentsecuritytoallownewentrantsinto
themarket.
Mutualization
IfwearekeepingFannieandFreddie,albeitinanewmarketwheretheymustcompete(moreonthisin
thenextsection),someoneneedstoownthem.Someoneneedstoprovideentity-levelcapitaltoensure
theiroperations.
Acriticalfailingofthepre-2008setupwasthat,becausetheywerepubliclytradedcompanies,the
GSEs—despitehavingamandatetoleadandservetheprimarymortgagemarket—hadanoverriding
fiduciarydutytotheirshareholderstomaximizetheirabilitytomakemoney.
Mutualization,anownershipstructurethatallowstheGSEstobecapitalizedandownedcollectivelyby
theirseller-servicers,avoidsthechallengesofotherownershipmodels.
Thisisnotanewidea.Therearesomeveryhelpfulprecedentsthatdemonstratetheviabilityand
benefitsofthismodel.Infact,itistheownershipmodelemployedbytheFederalHomeLoanBanks
8
(FHLBs).IntheFHLBstructure,memberspurchasesharesandhavecollectiveoversightoftheFHLBs.
Theonustokeeptheenterprisessolventisonthosewhousethem—theoriginators.
Themutualownershipmodeliscommonintheinsuranceindustryaswell,includingamongsuchgiants
asStateFarmandNewYorkLife.
Creditunions,too,aremutual,andtheU.S.hasalonghistoryofmutualsavingsandloans.
Oneoftheworld’slargestinvestmentcompanies,Vanguard,isamutual,asisanewandinnovative
municipalbondinsurer,BuildAmericaMutual,formedin2012.
Thereismuchtoborrowfromthismodel,andwebelievetheownershipstructurealignsincentivesina
waythatcanminimizethedesireto“chasemarketshare,”astheGSEsdidinthemid-2000s.
BytransformingFannieandFreddiefromGSEsintomutuallyownedandoperatedinsurers,lendersthat
arefamiliarwithsellingloanstoFannieandFreddiewillhavethechoicetocontinuetodoso.Butto
alignincentivesproperly,theselenderswillbecometheownersofthemutual.
Moreover,thecharterswouldnotbeexclusive.Lenderscouldbemembersateither,both,orneither
mutual.
Themutualownershipstructurealignsincentivesoncreditrisk,meaningthatboththeloanoriginators
andthecreditenhancershavedirectexposuretocreditriskandeachwillwanttocarefullymonitor
marketconditionsgenerallyandthequalityofloanproductionacrossthemembersofthemutuals.
Importantly,themutualapproachachieveswhatDodd-Franksoughttoaccomplish—skininthegame
forlendersandsecuritizers—butfailedtoachievebecauseofthewaytheregulationswerewritten.
Thistypeofstructureachievesoneveryimportantpolicygoal:alignmentofincentivesthroughoutthe
system.Ifthisalignmenthadbeeninplacebeforethecrisis,theincentivetosimplysellallrisktothe
GSEswithoutcareforloanquality—asinaccuracyofunderwriting—wouldnothavebeensoprevalent.
Andwhenwetalkaboutunderwritingqualityhere,thisisourprimaryfocus.Itisnotjustcreditscoreor
loan-to-value(LTV)ratio,butaccuracyofdocumentationandtheavoidanceofcarelessnesswiththe
underwritingprocess.
WhentheoriginatorsthemselveshaveastakeintheperformanceofFannieandFreddie,theincentive
toensurehigh-qualityunderwritingcanbemaintained.TheFHFAwouldhavestrongregulatory
oversighttomakesureofthis,asitdoesnowwithboththeGSEsandtheHomeLoanBanks.The
collectivepressureofanindustrywithastakeintheperformanceoftheloansitoriginatesisalso
helpful.
Anotherbenefitofthemutualstructureisthatitrewardsthelender-ownersforproducinggood-quality
mortgages.Intechnicalterms,thelenderscan“monetize”thevalueofproducingperforming
mortgages.Thismayproveespeciallybeneficialtocommunitylendersascomparedwiththeoldmodel.
Intheoldmodel,FannieandFreddieshareholderscapturedtheeconomicbenefitofgoodlending,
whereaslendershadnoeconomicincentivetobebetterunderwritersthanthenextguy.Community
lendersoftenarguedthattheyknewtheirlendingmarketsbetterthanthenationalplayersbuttheGSE
9
secondarymarketdidnotrewardthemforthat.Infact,communitylenderstypicallyreceivedlessfor
theirmortgageswhensellingthemtoFannieandFreddiebecausethenationalplayerswererewarded
forvolume.Amutualownershipstructurehelpstoshiftthisdynamic.
Goingastepfurther,ifcommunitylendersconcludethattheFannieandFreddiemutualsarenotserving
theirneeds,andinparticulararenotmonitoringandrespondingtopoorunderwritingbyother
membersofthemutual,theycanformanewmutual.Andsoasmalllender-onlymutualwouldallow
themtobenefitfromthequalityofloanstheyproducewhilenothavingtoworryaboutachieving
sufficientscaleforliquidity,sincetheGinnieprogramdoesthatforthem.
AnotherbenefittomutualizationofFannieandFreddie,inadditiontobringinginasteadyand
dedicatedsourceofcapitalfromlenders,istheinstitutionofaculturalchangeattheenterprises,in
particular,themanagerialfocus.Nolongerwouldtheenterprisesseetheirprimarymissionas
maximizingreturnsforcommonshareholders.TheownersofthereconstitutedFannieandFreddie
wouldwant—need,actually—themtobesteady,responsible,andreliablesourcesofcredit
enhancement.
Again,thisisnothingnew.Indeed,ithasaback-to-the-futureelementtoitsinceFreddieMacwasfirst
formedasamutualin1970andremainedsountilthelate1980s.EvenFannieMaeusedtorequireits
seller-servicerstoinvestinFannieMaeshares.
Followingourapproach,theservicesFannieandFreddieprovidetodaywouldcontinuetobeavailable
tolenders.Andtheworktheyhavedoneinthepastfewyearstodevelopcreditrisktransferswould
continue,sothatthemutualswouldnotwarehousemortgagecreditriskasintheoldmodelbutinstead
wouldsyndicateitacrossprivate-capitalmarketinvestors.
Asforgovernanceandownershiprules,weproposestartingwiththeownershiprulesoftheFHLBs.
Essentially,eachseller-servicerforthenewlycreatedmutualswouldpurchasesharesinthemutual
commensuratetotheamountofloanstheydeliver,buttopreventanyonelargelenderfrom
dominatingmanagerialdecisions,nolenderwouldhavevotingrightsthatexceedtheaverageownership
sharesize.Therewouldbeacaponvotingrightsthatlevelstheplayingfield.Again,thishasworkedfor
theFHLBsandcertainlycanforthenewFannieandFreddieandanyapprovednewentrants.4
Capital
Togettoasetofwell-capitalizedenterprises,weproposethatthenewlymutualizedFannieandFreddie
havecapitalthatcomesintwoforms.
First,theywouldberequiredtodocreditrisktransferonasubstantialportionoftheiroriginations,as
theyaredoingtoday.Areasonabletargetfortheamountoffirst-lossriskthattheywouldhavetoshed
couldbethefirst300to500basispointsoflossonroughly80percentto90percentofannual
4
Thedetailsofthegovernancestructureandthedevelopmentofatransitiontimelinearebeyondthescopeofthispaper.We
expectthattheFHFAwouldinitiateaprocessforlicensingorcharteringcredit-enhancementmutuals,includingthe
reconstitutedFannieandFreddie,beforetheconservatorshipsareended.Wealsoexpectthatissuesinvolvingtheinitialseed
capitalandallocationofthatcapitalwouldberesolvedbeforetheconservatorshipsendedinordertoensurethereisnogapin
service.
10
production.5Onceagain,thisisessentiallywhattheGSEsaredoingtoday,sotheimpactonrateswould
bepracticallynonexistent.
Creditrisktransfercanserveastheprimarysourceof“capital”inareformedFannieandFreddieand
amongnewentrants.Thereconstitutedenterpriseswouldbegiven,underFHFAauthority,theabilityto
choosethetypesandstructuresoftheseCRTtransactions,leveragingwhatworksbest,andwouldbe
requiredtoreportregularlytotheFHFAonthestructuresbeingused.Buttheywouldbesyndicatorsof
risk,notmassivetakersandholdersofmortgagecreditrisk.6
Still,evenwithCRT,someoneneedstoownentity-levelcapital,whichwouldprovideasecondarycapital
supportafterthecreditrisktransfer.Theentity-levelcapitalsuppliedbythemember-ownersofthe
mutualformsthebasisofthis.Itallowsthemutualtocontinuetooperateinasolventwayevenifcredit
lossesexceedthoseabsorbedbyCRTstructures.Thisishowmanyothermutualsoperate.
IfCRTamountstoroughly400basispointsofcapital,or4percent,webelievetheownersofthemutual
shouldberequiredtoputupsomewherearound2percentofadditionalenterprisecapitalinthe
companies.Iflossesweretomount—exceedingthecapacityofCRTandtheownershipshares,putting
solvencyatrisk—theownerswouldberequired,underFHFAdirection,toaddmorecapitaltokeepthe
mutualfunctioningandsolvent.Onewaytoavoidpro-cyclicalitywiththistypeofstructurewouldbefor
theindustrytoovercapitalizethemutualintimesofeconomicandlendinggrowth,sothatintimesof
stressthecapitalbasecouldshrinkabitwhilestayingabove2percent.
Finally,aswewilldiscussinalatersection,aMortgageInsuranceFund,paidforbytheindustry,would
backstopthesysteminatimeofextremestress.
CashWindows
AnimportantroleplayedbyFannieandFreddietodayistheirabilitytopurchaseloansforcashfrom
smallerlendersandthensecuritizetheseloansintoanMBSthemselves.Inourproposal,thenew
mutualizedenterpriseswillhavecashwindowswheretheycancontinuetopurchase,forcash,loans
fromthesesmalllenders.
Onecriticismwehaveofthecashwindowisthatattimesitmaynotperformasmuchqualityassurance
oftheunderwritingasitshould.Thisisstillaconcernwehave.However,whenthisprocessiscarried
outunderamutualownershiparrangement,thelender-ownerswillhaveanincentivetoensurethatthe
quality-controlmechanismsinplacearerobust.Infact,wewouldexpectthemutualtohavearobust,
lender-levelreportingsystemsothatthemember-ownerswouldseeandappropriatelyrespondto
lenderssellingpoorlyperformingloanstothemutual.Thoughit’sbeyondthescopeofthispaperto
outline,thereareseveralwaysinwhichtheincentivealignmentcanbetightenedfurtherbycreatinga
5
Weputthisrange,andatargetof90percent,asopposedtoahardfirst-lossamounton100percentofproductionsothat
creditrisktransfercanflexandbowascreditmarketsfluctuateduringthenormalcourseofeachyear’smarketcycles.By
allowingabitofflexibility,themutualscanberesponsivetothemarket’sdynamicsandsmoothinanychangesincreditmarket
interestrates.
6
Themutualcandecide—indeed,maybewisetodecide—torequireindividuallenderstoinvestintheCRTstructureofany
pooltowhichtheycontributeloans.
11
formofriskretentionwherelendersretainsomespecificcreditexposuretotheloanstheyselltothe
mutual.
Finally,weproposethatthenewmutualizedenterprisesbenotonlyasourceofcreditenhancement,
butthatonloanstheypurchaseforcash—andonlyonloanstheypurchaseforcash—theybeallowedto
betheissuerofagovernment-backedMBS.
Thisisanimportantpoint.Forthelargestlenders,thereconstitutedmutualswouldoperatemorelike
mortgageinsurers,guaranteeingtheprincipalandinterestpaymentstotheMBSholder,buttheywould
notbetheissuerofthesecurity(moreonthisinthenextsection,inourexplanationoftheGinnieMae
program).Thischangesubstantiallylessenstheirroleinthemarket,butitwouldaffectonlytheirlargest
seller-servicers,becausewewouldnotchangehowtheyoperatethecashwindowsfortheirsmaller
lendingpartners.Thatisbecausetheenterpriseswouldbepermittedtobeaggregatorsandissuersofa
government-backedsecurityforloanstheypurchasefromsmallerandmid-sizedlendersforcash.
Inordertomakesurethatnolargelenderstriedtoarbitragethisexecutionoption,wewouldpropose
thattheserulescomewithastipulationthatnolendercanrepresentmorethan5percentofeither
enterprise’scashwindowvolume.So,bydefinition,thecashwindowwouldbeforsmallerandmid-sized
lendersalmostexclusively.Largerlenderswouldneedtobetheissuersoftheirownsecurities,thus
givingthemmoreofanincentivetounderwritehigh-qualityproductionandbedirectlyresponsiblefor
thatproduction.
Thiswouldgivesmallerandmid-sizedlendersthreechoicesinhowtheyaccesstheMBSmarket.One,
theycouldissuesecuritiesthemselves(whichmanyalreadyaredoingthroughtheGinnieIIprogram,as
GinnieMaeallowssingle-loanpoolsandhasroughly400issuersalready).Second,smalllenderscould
sellloansforcashtoeithernewmutual,andthemutualwouldissuetheMBSontheirbehalf.Third,
smalllenderscouldcreatetheirownnewmutualorcouldselltheirloanstoanyoftheexisting400-plus
GinnieMaeissuers(again,asalreadyhappenstoday).
Itwouldbesensibletoassumethatothernewentrantsthatemergetocompetewiththereconstituted
FannieandFreddie—whichwewilldiscussinthenextsection—wouldwant,andshouldhave,thesame
capabilitytopurchaseloansforcashandissueagovernment-backedsecurity.
Step Two: Amendments to the Ginnie Mae Charter
GinnieMaeRefresher
GinnieMae,theGovernmentNationalMortgageAssociation,isoneofthemostimportantyetleast
understoodpillarsoftoday’shousingfinancesystem.Thissectionprovidesabriefreviewofhowthe
agencyfunctions.
GinnieMaetracesitsrootstotheestablishmentoftheFederalHousingAdministrationin1934andthe
FederalNationalMortgageAssociation(FannieMae)in1938.CongressestablishedGinnieMaeasa
governmentcorporationwithintheDepartmentofHousingandUrbanDevelopmentin1968bysplitting
FannieMaeintotwoentities:GinnieMaeanda“privatized”FannieMae.GinnieMae’srolewasto
12
guaranteemortgage-backedsecuritiescomposedofmortgagesinsuredorguaranteedbyfederalentities
suchastheFHAandVA.Infact,GinnieMaeissuedthefirstmortgage-backedsecurity(MBS).
TodaythetotaloutstandingamountofGinnie-guaranteedMBSis$1.7trillion.Withoutmuchfanfare,
GinnierecentlysurpassedFreddieMacintermsoftotalMBSoutstandingandisnowsecondonlyto
FannieMae,whichhas$2.8trillionoutstanding.In2016,accordingtosomeestimates,GinnieMaemay
surpassevenFannie.Inshort,theGinnieMaeprogramisgrowingfast.
Moreover,GinnieMaeMBStradesatapremiumtobothFannieandFreddieMBSinthemarket,
meaningthepriceforGinnie-backedbondsishigherandthereforetheyieldofthesebondsislower.
Thiscantranslateintoalowermortgagerateforthehomebuyer.ThispremiuminGinnieMBSstems
fromtheglobalacceptanceofthesecurity,includingbycentralbanksfromTokyototheEuropean
Union,and,mostimportantly,thefactthatGinnieMaeMBSprovidesafull-faith-and-creditgovernment
guaranteethatiswellknownbytheinvestorcommunity.
OnethingthatisdifferentaboutGinnievis-a-visFannieandFreddie,apartfromthefactthatthe
platformalreadyhasagovernmentwrap,isthatGinnieMaeisnottheissueroftheMBSwhenaGinnie
securityiscreated.Theselleroftheloans—theoriginator—istheissuerofaGinniesecurity.Theissuer
actuallypurchasesinsurancefromGinnieMae,whichprotectstheGinnieMBSinvestorincaseofissuer
default.
AnissuercanbeanyoneapprovedbyGinnieMae,andtodaytherearemorethan400approvedGinnie
issuers.ComparethiswithestimatesthattheGSEshaveroughly100institutionsthatsecuritizeMBS
throughthem(allothersusingthecashwindow).TheGinnieMaeprogramissubstantiallymoresmalllender-friendlythanthoseoftheGSEs.
Ginnieissuersrangefromcommunitybankstothelargestmegabanksandalsoincludenonbanksofall
sizes.Thevolumeofloansissuedalsovariesgreatlybyissuer,fromsomethatmayissueapool
containingjustasingleloan(note:Ginnie’splatformcanhandlesingle-loansecurities)tolargenonbank
lenderssuchasQuicken,ormegabankssuchasWellsFargoandChasethatmayissuepoolswith
thousandsofloansinagivenmonth.7
ToissueaGinnieMaeMBS,theoriginatorneedstodothreethings:obtaincreditenhancement—
essentiallyaformofmortgageinsurance—fromanapprovedsource;maintaincapitalandliquidity
standardsforissuerssetbyGinnieMae;andretainresponsibilityforloanservicing.TheGinniecharteris
veryshortandstraightforward.Amendingitasweproposewouldberelativelyeasy.
ThefirstrequirementforissuingaGinniesecurity—thepurchaseofcreditenhancementfortheloans
securitizedintoaGinnieMBS—mustadheretotherulesoftheGinnieMaecharter.Today’scharter
approvesthreemainformsofcreditenhancementprovidedbygovernmentagencies.8Theseagencies
7
http://www.nationalmortgagenews.com/news/secondary/nonbank-lenders-usurp-banks-as-ginnie-mbs-leaders1051188-1.html.
8
http://www.ginniemae.gov/about_us/what_we_do/Documents/statutes.pdf.
13
are:FHAinsurance,VAinsurance,andUSDAinsurance.Havingobtainedthecreditenhancement,the
issuerthenpurchasesMBSissuerinsurancefromGinnieMae.
14
CreditEnhancement
Itisthepurchaseofcreditenhancementthatwefocusonforreform,whilealsofocusingonchangesto
GinnieMae’scharterthatwouldallowittohavegreaterauthority,flexibility,andresourcestofulfillits
missionofissueroversight.
Creditenhancementisanyformofcreditprotectionthatpaysadefinedamounttothelenderor
investorintheeventofaborrowerdefault.Creditenhancementisessentiallyjustinsuranceprovided
againstcreditlossesfromborrowerdefaults.Therearemanywaystocredit-enhanceamortgageorpool
ofmortgages.
FannieandFreddietoday,throughtheirguaranteeofloansthatgointotheirMBS,aretheworld’s
largestcreditenhancers.TheFHA,atmorethan$1trillioninsize,isenormousaswell.Thecoreofour
proposalistoamendtheGinniechartertoallownewprivateentrantstocomeintothismarketforcredit
enhancementandcompete.
ByallowingnewentrantsbesidestheFHAtotakeonthisriskascreditenhancersaheadofGinnie,we
canleveragetheGinnieMBSmulti-issuerplatformwhilecreatingavibrantprivatemarketformortgage
creditrisk.
Likeotherformsofinsurance,creditenhancementspreadsrisk.Inapoolof100loans,forexample,
defaultmodelscanprojectthattwoarelikelytodefault,butwedon’tknowwhichtwotheywillbe.
Modelsandhistoricaldataalsotelluswhichonesaremore(orless)likelytodefault;thatis,whichloans
aremore(orless)riskythanothersinthepool.
Forthepurposesoftheremainderofthispaper,weseetwoformsofcreditenhancementbeingusedto
capitalizethecreditenhancersinthesystem.
First,wewouldallowthereconstitutedFannieandFreddietobecreditenhancersunderanew
ownershipstructure,asdiscussedearlierinthispaper.Butwewouldletthemdosoinacompetitive
environmentwhereothernewentrants—onceapprovedandregulatedbytheFHFA—areallowedas
well.IngeneralonecanthinkofthesefirmsandthereconstitutedFannieandFreddieas“guarantors”or
even“mortgageinsurers.”Yetwearecarefulwiththeword“insurance”fortworeasons:One,these
wouldnotbestate-charteredinsurancecompanies,andtwo,theywouldberesponsiblefortheentire
riskoftheoutstandingunpaidprincipalbalanceofeachloantheyguarantee.Thisisdifferentthan
traditionalmortgageinsurance,whichinsuresonlyaportionoftheloanbalance.Also,itisconceivable
thattheprivatecreditenhancementweproposewouldworkwithlessthan100percentofthepossible
creditriskbeingtransferred.Forthattowork,however,theresidualcreditrisk,whichwouldremain
withtheMBSissuer,wouldneedtobesufficientlyremotetoavoidtheloansbeingconsolidatedbackon
thebooksoftheissuer.9
9
With100percentoftherisktransferred,thecatastrophicriskendsupwiththeMortgageInsuranceFunddescribedlaterin
thispaper.Withlessthan100percentrisktransfer,thecatastrophicriskwouldbedistributedacrossalltheissuers.Ineither
event,sincewewouldrequireallissuerstohaveskininthegamewithregardtocreditenhancementviatheirownership
interestinthecreditenhancer,theissuersretainmeaningfulresponsibilityforthecreditqualityoftheloanstheysecuritize.
15
Second,boththenewFannieandFreddieandanynewentrantswouldberequiredtotransfercreditrisk
tothemarket,makingthempartconduitsofmortgagecreditriskandpartholdersofmortgagecredit
risk.ThisislargelytheoperationalstructureoftheGSEstoday,astheyhaveslowlybeentransforming
themselvesintocreditsyndicatorsviathecreditrisktransferprogramsinitiatedbytheFHFAin2012.
This,too,isaformofcreditenhancement,andwewouldadvocatethatthenewsystembuildoffthis
workandtheseprograms.
LeveragingGinnieforReform
Onestepthatpolicymakerscanandshouldtake,eitheronitsownoraspartofcomprehensivereform,
istogiveGinnieMaegreatercontroloveritsbudgetandresources.Asalreadynoted,theprimaryrisk
Ginniefacesisthatoneofitsissuerswillbeunabletomakegoodonremittanceofscheduledprincipal
andinterestpayments.Typically,aGinnieissuerwillrelyonthecreditinsuranceofferedbytheFHAor
anotherfederalprogramtoensurethatitcanmakebondholderswholeintheeventofborrower
defaults.Butuntiltheloanmodificationprocessortheforeclosureiscompleted,theissuermust
advancepaymentstoinvestorseachmonth.
Historically,whenbanksandthriftsdominatedGinnieMaeissuance,GinnieMae’sriskwaslargelybased
onanissuerlosingaccesstoliquidityorrunningoutofcapitalduetounrelatedevents(suchaslosseson
itsotherbankingactivities).Today,however,withcomplexandcostlyloss-mitigationrequirements,
lengthyforeclosuretimelines,andtheriseofnonbankservicersthatdonothaveaccesstobanks’
traditionalfundingsources(suchasdeposits,FHLBadvances,andtheFederalReserve),theriskofan
issuerliquiditycrisisissomethingGinniehasbecomemorefocusedon.GinnieMaestillchargesits
issuers6basispointsinrateforthisinsurance,which,ona$1.7trillionMBSbase,generates$1billion
peryear.
However,withGinnieoperatingaspartofHUD,thesefundsaredepositedatTreasuryandthendirected
elsewhereviatheappropriationsprocess.Ginnie,forexample,hasbeenunabletospend$4millionon
additionaloversightresourcesrequestedtoexaminethenonbankissuersusingitsplatform.Ginniehas
beenseeking,evenifnotaspartofbroaderreform,theauthoritytospendasmallfractionofthemoney
itbringsinonaprocessformorerobustoversightandstresstestingofitsissuers.Butbecauseitdoes
notcontrolitsownrevenues,itcannotspendtheseresources,eventhoughtheyaremeagerrelativeto
thefundsGinniegeneratesfortheTreasury.Ataminimum,thisdynamicneedstochange.
WhencoupledwiththepowerofusingtheGinnieplatformasabridgetoanewhousingmarket
structure,however,afewchangestoGinniecanbeenormouslysignificant.
Thefirststepswepropose—whichcomewiththesupportofpastGinnieMaepresidents10—istoamend
theGinnieMaechartertobringitoutofHUDandallowittosetitsownbudgetoutsideofthe
appropriationsprocess.Operatingamultitrillion-dollarfinancialguaranteeandsecuritizationbusiness
requiresfinancialsophistication,andGinnieMaeshouldbetreatedlikethebankregulatoryagenciesin
termsofemployeehiringandcompensationrules.
10
http://www.scotsmanguide.com/News/2016/05/Ginnie-Mae-should-be-separated-from-HUD--former-Ginnie-presidentsays/.
16
OnceGinnieisgivenenhancedbudgetautonomyfromoutsideofHUD,itisarelativelyeasystepto
allowittobetheplatformthatcreatesabridgetoanewandmorecompetitive,dynamicmortgage
creditsystem.
NewCreditEnhancers
AssumingGinnieMaeastheplatformandthesourceofthegovernmentguaranteeincreatingarates
instrumentforthemortgagemarket,howdoesthismodeldealwithcreditrisk?Today,loansinGinnie
poolsreceivecreditenhancementfromoneofseveralgovernmentguaranteeprograms(chieflyFHAand
VA).Weproposethatanadditionalsourceofcreditenhancementbepermitted:privatecredit
enhancementprovidedbyalicensedcreditenhancerthatraisesprivatecapitaltosupporteach
individualpoolandthathasadditionalentity-levelcapitaldedicatedtobackstopthecreditguarantee.
Thisiswhatallreformproposalshavesought:dispersing$5trillionofmortgagecreditriskthat
traditionallyhasbeenentirelyconcentratedonthebalancesheetsofFannieMaeandFreddieMac.
Thisfigureshowsthebefore,current,andafterviewofwhatwearetryingtoachieve.Before2013,
FannieandFreddieretainedallthecreditriskonallthemortgagestheyboughtorsecuritized,beyond
anyloan-levelmortgageinsuranceonlow-down-paymentmortgages.Aswelearnedin2008,thiswasa
perfectrecipeforsystemicrisk.
17
Beginningin2013,FannieandFreddie’sconservator(oneofthispaper’sco-authors)directedthemto
beginsellingaportionofthisriskexposuretoprivateinvestors.Usingavarietyoftransactiontypes,
FannieandFreddiehavebeensellingoffanincreasingamountofthisexposure.(Atechnicaltermfor
thisisthatFannieandFreddiehavebeensyndicatingtherisk,thatis,buyingitallupandthen
distributing[syndicating]alargeportionofittootherinvestors.)
Inthenewsystemweareproposing,thisrisksyndicationwouldbebroadenedtocoverallsecuritized
loanpoolsandcouldbeperformedbyawidearrayofmarketparticipants,notjustthereconstituted
FannieandFreddie.Thisopensthefieldtoallownewparticipantsintothecredit-enhancementmarket
formortgages.WedonotwantFannieandFreddie,evenifreconstitutedasmutuals,tobetheonly
playersinthemarketplace.
Inshort,creditenhancementonGinnieMaeMBSwouldcomefromarangeofentities,allofwhich
woulduse—astheGSEsdotoday—creditrisktransfermarkettransactionsinwhichthecashfor
potentialloanlossesisprovidedupfrontandheldinreservetooffsetlossesandhelpbuildavibrant
marketformortgagecreditrisk.
ByopeningtheGinniechartertootherapprovedentrantstoprovidecreditenhancement,wecanend
today’srelianceonalimitedsetofgovernment-runentitiestoprovidethismortgageinsurance.Wecan
alsogreatlyreducesystemicrisk,becausethe$5trillioninmortgagecreditriskthatistoday
concentratedonFannieMaeandFreddieMac’sbalancesheetswouldbemorewidelydispersedacross
thefinancialsystem,whereitcanbereviewedbycountlessinvestorsandanalystsandbepricedand
tradedintransparentmarkets.Mostimportantly,withinwell-definedparametersthatensureequitable
andnationalaccesstothesystem,wecanallowfordisruptionandinnovationinthesecondary
mortgagemarketfromnewcompetitors.
18
IfpolicymakersusetheGinnieMaeplatform,whatwedescribe—usheringinanewmarketformortgage
creditrisk—wouldnotbeverydifficulttodomechanically.Ginniealreadyhasinplaceasystemthat
verifiesthatanissuerhasobtainedapprovedcreditenhancementfromoneofthesourcespermittedin
itscurrentcharter.Byaddingadditionaloptionstothisquery,itwouldverifythesourceofthecredit
enhancement,includingfromlicensednongovernmentsources.
Say,forexampleandforsimplicity’ssake,thattheGinniecharterwasamendedtoallowacredit
enhancementobtainedbyareconstitutedFannieMaetocountasaneligiblecreditenhancement.
GinniecouldamenditssystemtoestablishaprocesstocheckwithFanniethatloansbeingbroughtfor
GinniesecuritizationhadinfactobtainedcreditenhancementfromFannie.Inthisway,aloancreditenhancedbyFanniecouldaccessafull-faith-and-credit-guaranteedMBS.
Alternatively,andmoreinterestingly,assumethatanewentranthadaviableideatodisruptand
improvehowmortgagecreditrisk-takingandsyndicationcouldwork.Thisisnotentirelytheoretical.In
fact,sometraditionalmortgageinsurersareevolvingtheirbusinessmodelstobeinnovativedevelopers
ofcreditrisksyndicationtoday.Byallowingthemtocompeteinthismarket,wecannotonlyenhance
customerservicebutcanresponsibly(e.g.,subjecttoqualifiedmortgage[QM]rules)expandaccessto
homeownershipopportunities.
NewentrantswouldsimplyapplytotheFHFAtobeanapprovedcreditenhancerforloansissuedoffthe
GinnieMaeplatform.Oncetheywereapproved,Ginniewouldaddthemtoitsprocessforcheckingfor
theexistenceofsuitablecreditenhancement.
Then,aGinnieissuerputtingtogetherapoolofmortgagestobesecuritizedthroughGinniecould
purchasecreditenhancementfromthenewlyapprovedentrantwhilesimultaneouslypurchasinga
GinniewrapontheMBS.Byallowingnewentrants,wewouldmorebroadlydispersecreditriskanddo
soinawaythatreliesonprivatecapitalandallowsfornewcompetition.Theissuerwouldstillbe
responsibleforensuringtimelypaymentstoinvestors,asitistoday.
Inthistypeoftransaction—thatis,whenanissuerobtainscreditenhancementfromanewentrant—
therewouldbenoinvolvementwhatsoeverfromFannieorFreddie.Bydefinition,then,openingthe
GinniecharterwouldreducethesizeofFannie,Freddie,andpotentiallytheFHA.
HowWouldItWork,Mechanically?
WeproposethatCongressamendtheGinniechartertoallownewprovidersofcreditenhancement.To
establishrulesthatprovidemarketstability,wewouldrequirethatGinnieandtheFHFAjointlyapprove
anynewformofcreditenhancementandestablishclearpolicycriteriaforanynewentranttobe
approved.
Onthelatter—theoutlineofpolicycriterianecessaryforanynewentranttobeapproved—weadvocate
thattheGinniecharterbeamendedtostatethefollowing:
19
NewentrantsmaybeapprovedascreditenhancersaspartofaGinnieMaesecuritizationsolongas
they:
a. Canshowadedicationtomortgagecreditthroughtheeconomiccycle,nationally,servingall
markets
b. Canofferanownershipstructure,suchasamutualorco-op,thatgivesloanoriginatorsa
meaningfullevelofownershipintheperformanceofloanstheycredit-enhancethroughanew
entrant
c. Cansyndicateasubstantialportionoftheirfirst-losscreditrisktothemarkets,astheGSEsare
doingtoday
d. Arewell-capitalizedandcanpassstringentregulatorycriteriatoensurecapitalandliquidityin
severelystressedeconomicenvironments
e. Improveaccesstocreditforlow-incomeborrowers
f. Havemanagementwithextensivemortgagefinanceandmortgagecreditriskmanagement
experience
g. Canstructureexecutionthatachievestruesaleaccountingfortheoriginator
h. Canenhanceexecutionoptionsforsmalllendersandareprohibitedfromgivingpricingfor
volumediscountstolargelenders
Byestablishingthesepolicycriteriainlegislation(thatis,byaddingthemtotheGinnieMaecharter)but
allowingGinnieandtheFHFAtojointlyapprovenongovernmentsourcesofcreditenhancement,we
wouldallowthemarkettoreplacetaxpayercapitalwithprivatecapital,bemoredynamic,andevolve
withshiftingmarketdynamics,withinthesedefinedpolicyparameters.
WhatIfaGinnieIssuerWantedtoCredit-EnhanceItsOwnProduction?
OneoftheinterestingpossibilitieswithusingtheGinnieMaeplatformisthatanissuercould,intheory,
decidethatitwantedtocredit-enhanceitsownloans.Wethinkthisisascenariothatshouldbe
permitted.
Forexample,sayalenderoranaggregatorthatwasaGinnieMaeissuerwantedtoissuesecuritiesoff
theGinnieplatform,butinsteadofobtainingcreditenhancementfromaseparateentityitwantedto
structureandsyndicatethecreditriskitself.Thisisverymuchakintosomeoftheso-calledfront-end
creditrisktransferdealstheGSEsaredoingtoday(e.g.,PennyMacandRedwood).Wethinkthisshould
beallowedsolongasthefollowingrequirementsaremet:
a. TheissuerwouldneedtosyndicatethesameamountofriskaswearerequiringthenewFannie
andFreddieandanynewentrantstoshed:300to500basispointsoffirstloss.
b. Theissuerwouldneedtoproduce“representativesample”poolssothatitcouldnotdothison
onlyoneriskcohortofloans.Thiscanalsobethoughtofas“nocherrypicking.”Again,thereis
precedentforthisinsomeofthefront-endCRTdealsbeingdonetoday.
c. Theissuer—andthisiswhereweaddanewdimension—wouldneedtoretainonitsbalance
sheetamezzanineownershiptrancheinthepools,inordertoretaintheskin-in-the-game
frameworkweproposeforthemutuals.ThiswouldmeanthataGinnieissuerwouldsellapiece
of,say,zeroto400basispointsoffirstlossbutthenretainonitsbalancesheetthenext200
basispointsoflosstobackstopthefirst-losspieces.Inthiswaytheissuersstillhaveanincentive
toproducewell-underwrittenpools,becausetheysharesomeofthelossrisk.Andwewould
achievecapitalequivalencyacrossallexecutiontypes.
20
Itisunclearwhethersuchamarketwouldgrowandevolve,butwewouldnotruleoutthepossibility,
anditcouldoffersomesubstantialbenefitstocreatingawideanddeepcreditriskmarket.Itmayvery
wellbethatthemarketwouldbewillingtopurchaseonlythefirst400basispointsoflossiftheissuer
(whichisalsotheservicer)alsoheldaportionofthefirst-lossrisksothatthemarkettrustedthefirm’s
commitmenttoservicetheloansproperly.Thishasbeenadynamicthathasplaguedtheattemptsat
revitalizingtheprivate-labelsecurities(PLS)market.Butwewouldleavethattotheoriginatorand
marketparticipantstoworkout.SolongasthecapitalisaheadofGinnie,somuchthebetterifthe
issuerholdsapieceoffirst-lossrisk.
Aslongasthesepoolsachieveallofthepolicyobjectivesbehindthemutual—nationalanddiverse
loans,abilitytoservelow-incomemarkets,skininthegamefortheissuer,andcollateralizedcreditrisk
transferaheadoftheGinniewrap—webelieveitcouldbeahelpfulandadditivepartofthemixof
optionsforlenders.
CommunityBanks,Thrifts,andCreditUnions
AcommonconcerninhousingfinancereformdebatesisthatanysystemthatisnotbasedonFannie
andFreddieastheyexisttodaywouldleavecommunitybanks,othersmalldepositoryinstitutionssuch
assavingsandloansandcreditunions,andevenmid-sizedlendersandnonbanklendersoutinthecold.
Theframeworkweproposehasmanyadvantagesforthesesmallerplayers.
AcriticalfeatureoftheGinnieMaeplatformisthatsmallerissuersgetthesamepricingaslargerissuers,
therebybenefitingdirectlyfromthescaleprovidedbylargeissuers.RelativetotheFannie-Freddie
model,smallerplayersthatdonotwanttobeissuersthemselveshavehundredsofissuerstosellto,not
justtwo.
Intheframeworkproposedinthispaper,smallerlenderswouldstillhavetheFannieandFreddiecash
windowsavailable,withtheaddedbenefitofbeingpart-ownersofthesemutual.Asmutuals,the
reconstitutedFannieandFreddiewouldservetheirmember-ownerswithmuchimprovedincentive
alignmentrelativetotheoldsystem.
Evenwithallofthat,additionalopportunitiesremainthatwouldbenefitsmallerlenders.Acommunity
bankcreditrisksyndicationactuallyexiststoday.ItistheoriginalMortgagePartnershipFinance(MPF)
programoftheFHLBs.Thatprogramsyndicatescreditriskamongcommunitybankswhileseparately
financingthelong-termmortgages.Moreover,thisexamplealsopointstoanotherimportant
competitorintheframeworkwepropose:theFederalHomeLoanBanks.TheFHLBsarealreadyGinnieapprovedissuersandtheMPFandrelatedprogramshaveabuilt-ininfrastructuretohelpcommunity
banks,savingsandloans,andcreditunionsaggregatemortgages,syndicatecreditrisk,andaccessthe
secondarymortgagemarket(throughGinnieandFannieandFreddie).WebelievethattheFHLBsarea
logicalcompetitivealternativetothemutualizedFannieandFreddieandtoothercreditenhancement
options.Theyalreadyhavethemutualstructure,communitybankfocus,andthemortgagemarket
21
expertisetobuilduponinprovidingacompetitivealternativeinthemarketstructurewepropose
here.11
WhyGinnieandNottheFMIC/CSP?
Thosewhohavefollowedorparticipatedinhousingfinancereformdiscussionsthepastseveralyears
knowthatin2012,theFHFA(atthetimeledbyoneofthispaper’sco-authors)initiatedacommon
securitizationplatform(CSP)toreplaceFannieandFreddie’srespectiveproprietarysecuritization
systems.TheCSPwasfoldedintomostsubsequentreformproposalsandisstillbeingdevelopedtoday.
IntheJohnson-Crapobillandotherproposals,theCSPwastobethesecuritizationinfrastructureon
whichMBSguaranteedbyanewfederalagency—theFederalMortgageInsuranceCorporation(FMIC)—
wouldbeissued.
Whilethisremainsaviablepolicyalternative,concurrentdevelopmentsatGinnieMae,inourview,now
provideabetteralternative.AtaboutthesametimeworkontheCSPbegan,GinnieMaeinitiatedan
overhaulofitssecuritizationplatform.Thisworkhasproducedanoperating,multi-issuersinglesecurity
wrappedbyafederalguarantee—thesameoutcomeasenvisionedinthesevariouslegislativeproposals
fortheCSP.Moreover,thetechnologyisalreadytested,thepipesareworking,andtheloan-level
disclosuresenvisionedwhentheCSPwasannouncedarealreadyarealityintheGinniemodel.
Inaddition,theGinnieplatformisalreadybuilttoacceptmultipleformsofcreditenhancementandcan
beadaptedtoaddmore.TheCSP,ontheotherhand,hasbeenfocusedonservingjustFannieand
Freddiethepasttwoyearsandisstillmorethanayearfrombeingfullyoperationaljustforthose
enterprisesalone.
Itisentirelypossible,infactlikely,thattheCSPcouldbeusedtoenrichthecurrentGinnieMae
platform.12Thus,ifCongressweretopursueusingtheGinnieMaeframeworkaswearerecommending,
webelieveitshoulddirectGinnieMaeandtheFHFAtocollaborateonadetaileddue-diligencereviewof
theCSPtodetermineitsoptimaluseinthisnewframework,whetherthatmeansadaptingitintothe
Ginnieplatformordistributingsomeorallofitscomponentstothenewcredit-enhancementmutuals,
orsomeotherpath.Inanyevent,sincetheCSPisajointassetofthetwoconservatorships,everyeffort
shouldbemadetomaximizethereturnonthisinvestmentforthebenefitofthefuturesecondary
mortgagemarket.
11
TheevolvingcompositionofhousingfinanceplayerssuggestsotherpolicyquestionsinvolvingtheFHLBs,suchaswhether
mortgageREITsorothersshouldbeofferedmembershipinthesystem.TheFHLBswerecreatedmorethan80yearsagoto
provideasourceofliquidityforsavingsandloans,whichatthattimeweretheprincipalsourceoffinancingmortgages.Since
thenmuchhaschanged.Securitizationthatproducesamortgagecreditmarketseparatefromthefundingmarket,andthe
increasingdominanceofnonbankloanoriginators,servicers,andholdersofmortgage-relatedassetssuggestssomepolicy
st
rethinkingaboutthepurposeandroleoftheFHLBsinthe21 centurymortgagemarket.TheFHLBsareadifferenttypeof
government-sponsoredenterprisethanFannieandFreddiebutareGSEsnonetheless.Whetherchangesorexpansionintheir
membershipandpurposearewarrantedrequirescarefulpolicyconsiderationandisnotasteptotakelightly.Inanyevent,an
importantoperationalissueinhousingfinancereform,includingwiththisframework,istheavailabilityandstabilityoffunding
forwarehousingmortgageproductionandforpaymentadvancestoMBSholders.Wewillexplorethatissuefurtherinalater
paper.
12
ForFHFA’smostrecentstatusreportonthecommonsecuritizationplatform,see
http://www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-Details-Plans-and-Timelines-for-the-SS-and-CSP.aspx.
22
SmalllendersbenefitfromaGinniemodelinparticularbecauseofhowtheGinniepoolswork.Under
GinnieII,whichisbyfarthedominantGinnieprogram,allloansdeliveredinagivenmonthfor
securitizationinaGinniesecurityareaggregatedtogetherandissuedunderthesamealphanumeric
code.ThussmalllendersthatareapprovedGinnieissuershaveaccesstothesecuritizationmarketand
benefitfromthescaleprovidedbyother,largerissuerswhosepoolsareallaggregatedtogetherby
Ginnieeachmonth.ThisisabenefituniquetotheGinnieMaeplatform.Itisdesignedtobeaplaying
fieldequalizer.
WhiletherestillmaybebenefitstobedrawnfromtheCSPdevelopment,theGinnieplatformis
operationaltoday.Moreover,itcomeswithagovernmentcatastrophicguaranteeofthesecurity
alreadybuiltin.Thus,thereisnoneedtocreateanddevelopanewfederalentity.
Finally,andimportantly,thesecurityisalreadyhighlyliquid.Wecanbuildoffa$1.7trilliongovernmentbackedGinnieMBSmarketthatiswidelyacceptedacrosstheglobe.
Tosummarize,weproposetwomainchangestotheGinnieMaecharter:
1. MoveGinnieMaeoutofHUDandgiveitcontrolofitsfinances
2. AllowcreditenhancementapprovedbyGinnieandtheFHFAthatisoutsideFHA,VA,orUSDA
insurance
Step Three: Amendments to the FHFA Charter
ConsolidatedHousingFinanceRegulator
Crucialtothereformsweproposeisastrongcentralregulator,whichwebelieveshouldbetheFederal
HousingFinanceAgency.TheFHFAcurrentlyhasoversightauthorityfortheGSEsandtheFederalHome
LoanBanks.Weproposegivingitadditionalauthoritytoapprovenewformsofcreditenhancementand
newentrantsintothecredit-enhancementmarket.
23
TheFHFAwouldbetaskedwithoverseeingthecapitaladequacyandotherrequirementsimposedonall
creditenhancers(includingonthereconstitutedFannieandFreddie);allacceptableformsofcredit
enhancement;andanynewcredit-enhancerentrants.Inparticular,weenvisiontheFHFAhavingexpress
authoritywithregardtoprudentialoversightofanycreditenhancersinthesystem,asthesefirms’very
existenceandbusinessoperationsareentirelydependentonthisnationalmarketthatwouldrun
throughGinnieMae.ThisoversightauthorityisalreadywellwithintheFHFA’scorecompetency.
BybringingallGinniecreditenhancersundertheFHFAregulatoryumbrella,theFHFAcangeta
consolidated,bird’s-eyeviewofnearlytheentirehousingmarketandensurethatitissafelyandsoundly
fulfillingtheneedsofAmericanhomeowners.ItwouldalsolenditssupervisoryexpertisetoassistGinnie
MaewithGinnie’skeychallengetoday:howtoset,monitor,andenforceprudentialguidelinesonGinnie
issuers,particularlynonbankissuers(sincebankissuersarealreadysupervisedbyaprimaryfederal
bankingagency).
TheamendmentstotheFHFAcharterwouldnotbeonerousorlong.Theywouldsimplyneedtoadd
resourcesandpersonneltooverseetheapprovalofnewentrantsandnewformsofcredit
enhancement.Inmanyways,thisissimplyanextensionoftheworktheFHFAisdoingnowinexploring
differenttypesofcreditrisktransfer.
Ultimately,thereformsweareproposingcouldlargelybelookedatascreditrisktransfersthatdonot
relyonnegotiationswithFannieorFreddie.Anoriginatorwillhavemultipleoptionsforwhatitcando
withthecreditriskontheloansitoriginates.ItcouldsellittotheFHA,totheFannieorFreddiemutual,
ortoanewlyapprovedmutual,oritcouldcredit-enhanceitsownpoolsandretainsomeownershipin
theirperformance.
Creditenhancers,inturn,couldsyndicatesomeoftheriskbypurchasingdeepermortgageinsurance
fromanapprovedinsurer;theycouldraisecashcollateralfrominvestorsinfirst-losscreditrisk,suchas
aninsurerorREIT;ortheycouldfindnewandinnovativewaysoffosteringamortgagecreditrisk
market.Aslongastheyretainsomeskininthegame,wewouldallowthemarketforthesestructuresto
evolveandgrow.
TheFHFA’sjobwouldbetoensurethatalloftheseentitieshaveadequatecapitalandoperational
capacity,justasitdoesnowformorethan$5trillionincreditriskmanagedbytheGSEs.AndtheFHFA
wouldbechargedwithensuringeconomiccomparabilityacrossallformsofcreditenhancementand
creditenhancerssoastomitigatecapitalarbitragegamesthatwereinherentinthepre-crisisGSE
model.
MortgageInsuranceFund
Finally,weproposeamendingtheFHFAchartertomanageabackstopMortgageInsuranceFund(MIF).
TheFHFAshouldcollectasmallfee,ontheorderof5to10basispointsperloan,fromallapproved
secondarymarketcreditenhancers,includingtheGSEmutuals.Overtimethisfundshouldbebuiltupto
roughly1percentto2percentoftotaloutstandingproduction;itwouldserveasabackstoptoallowthe
FHFAtofacilitatethewindingdownandtransferofthebookofbusinessfromanycreditenhancer
facinginsolvency.
24
LiketheFDIC’sDepositInsuranceFund,theMIFwouldallowfortheorderlydispositionofabookof
business.AswiththeFDIC,MIFpremiumswouldbuildareservethattaxpayerswouldbackstop.Inthe
eventtheMIFwasdepleted,ongoingMIFpremiumswouldrepaytaxpayersandrebuildtheMIFreserve.
Anadditionalpossiblefeaturewarrantsconsideration.Thehousingfinancereformproposaladvanced
byReps.Delaney,DemocratJohnCarneyofDelaware,andDemocratJimHimesofConnecticutalso
proposedrelyingonGinnieMaeratherthancreatinganewfederalguarantoragency.Importantly,their
proposalalsocalledonGinnieMaetoreinsureaportionofitscatastrophicriskwiththeprivate
reinsurancemarket.Thatideacouldbeappliedtoourmodelaswell,andtheMIFcouldberequiredto
reinsureaportionofitsriskandusethemarketpricefromthatreinsurancetohelpinformthefeeit
chargesforitsbackstop.
Operational Questions for Our Proposal
Belowisasummaryofafewoftheoperationalquestionsourproposalraises.
1. Whathappensifanissuerbecomesinsolvent?
TodayGinnieMaefacestheprincipalriskofanissuerbecomingcash-flow-insolventandtherefore
unabletoremitprincipalandinteresttotheGinnieMBSholder.Weproposenochangetothis
structure.Inthecaseofanissuerfailure,GinnieMae,asitdoestoday,wouldinitiateitswell-understood
processfortransferringtheissuer’sbookofbusinesstoanother,well-capitalizedGinnieissuer.
2. Whathappensifacreditenhancerbecomesinsolvent?
SimilartohowGinnieresolvesanissuer,theFHFAwouldresolve/transferthebookofbusinessofa
failedcreditenhancer.If,forexample,theFanniemutualwasnearinsolvency,theFHFAwouldinitiatea
processofattemptingtorecapitalizeitthroughitsowners.Ifitbecameclearthatsuchrecapitalization,
forwhateverreason,wasnotviable,theFHFA,byleveragingitsMIF,wouldinitiateaprocessof
transferringthisbookofbusinessaswell.Itisforthisreasonthathavingmultiplecreditenhancersthat
leveragemultipleformsofcapitalandcreditrisktransfermakessense.Itallowsforthefailureof
individualcreditenhancers,withthecostofthosefailuresbeingbornebythehousingfinanceindustry.
AnydrainingoftheMIFbyaninsolventcreditenhancerwouldrequireitsrecapitalizationbyremaining
secondarymarketparticipantsoncemarketconditionssettleddownandrecapitalizationwasviable.
3. Whathappensifaborrowergoesintodefault?
Inthecaseofborrowerdefaults,theGinnieMaeissuerwouldfirstpursueloss-mitigationeffortsto
avoiddefault(assetforthinConsumerFinancialProtectionBureauservicingrequirements).Itwould
theninitiateaprocessoffilinganinsuranceclaimwiththeentitythatprovidestheinsuranceandcredit
enhancement.ThisisperfectlyanalogoustotheprocesstodayattheFHA.InaGinniesecuritization
today,whenaborrowergoesintodefault,theissuercontinuestoremitP&Iuntilsuchtimeasitcanfile
aninsuranceclaimwiththeFHA.Underourproposedsystem,thisprocesswouldbethesame,
regardlessofwhetherthecreditenhancementwaspurchasedfromtheFannieorFreddiemutualora
newentrant.TheissuerpaystheGinnieMBSholderparfortheloanonapredeterminedschedule,as
donetoday.
4. WhathappenstotheCommonSecuritizationPlatform?
WeproposeGinnieMaebedirectedtoundertakeaduediligencereviewoftheCSP.Ifitfindsavalue
propositionforitsoperations,GinnieMaeshouldbeauthorizedtopurchasetheCSPonacost-plus
basis.IfGinnierejectssuchapurchase,thentheFHFA,asconservator,inconsultationwiththeTreasury
25
DepartmentundertheexistingTreasurysupportagreements,wouldoffertheCSPforsaletothe
market,perhapsasautilityforanylicensedcreditenhancer,includingtheFannieandFreddiemutual.A
thirdoptionistoselltheplatformtosupportarevitalizedprivate-labelmarket.
5. WhatistheprocessforendingtheconservatorshipsoftheGSEs?
OnceFannieandFreddiearereadytoberecapitalizedasmutualsbytheirlenders,andanew
governancestructureisestablished,theywouldbeputthroughreceivershipandemergeasnewlenderownedcreditenhancers.TheFHFA,asreceiver,couldcontractwiththesenewentitiestomanagethe
runoffoftheconservatorshipbooksofbusiness.
Atthetimetheconservatorshipsareended,alloutstandingFannieandFreddiesecurities,including
theirMBS,wouldremainbackedbytheTreasurysupportagreements.Anoptionthatcouldbeexplored
iswhethertopermittheresecuritizationofsome(themostrecentlyissuedMBS,say),orperhapsall,of
thesesecuritiesthroughGinnie.
Summary of Taxpayer Capital Protection
Tosummarizetaxpayerprotections,thecapitalunderourstructurecomesfromthreesources:
1. ThenewFannieandFreddiemutualsandanynewapprovedcreditenhancerswouldberequired
toshedcreditriskviacreditrisktransfersasrequiredbytheFHFAandGinnieMaetoachieve
therequiredlevelofcreditenhancement;400basispointsisasensiblestartingpointfor
discussion,asitistheamountofrisk-basedcapitalacommunitybankmustholdformortgages
initsportfolio.
2. Behindthis,eachcreditenhancerwouldhaveanoperatingcapitalcushionmadeupofshare
ownershipfromitsmembers.TheFHFAwouldbemandatedtodesigncapitalrulesforall
marketparticipantssubstantiallysimilartothetotalamountofcapitalrequiredoftheFannie
andFreddiemutualsfromthecombinationofCRTandlender-ownedshares.Somethinginthe
areaof2percentseemstomakesense.TheFHFAwouldconductregularstresstests,similarto
thoseconductedbytheFederalReserve,ofallapprovedcreditenhancers,whileGinnieMae
wouldconductregularstresstestingofitsapprovedissuers.Anycapitalinadequacyunder
adverseconditionswouldrequiretheraisingofadditionalcapital.
3. Finally,anMIFofroughly1percentto2percentwouldbecreatedtobackstoptheentiresystem
andmanageanorderlyresolutionofanyentitythatfacesinsolvency.
Intotal,thesystemwillhaveanapproximately8percentunexpected-lossabsorptioncapacityplus
substantiallyenhancedregulatoryoversightinfrontoftheGinnieMaebackstopguarantee.
WewouldalsoproposethattheFHFAbegiventhemandatetoexplorethemarketforcatastrophicrisk
reinsuranceoftheMIF.
26
Impact on Interest Rates
Anyhousingfinancereformproposalwillofcoursepromptthequestion:Whatdoesthisdotoborrower
interestrates?Webelievethatourapproachwillhaveaminimalimpactonrates,forafewreasons.
First,theprimarysourceofcapitalthatweare“bringing”intothesystemcomesviacreditrisktransfer
securities.Thisroughly400basispointsofcapitalwillbethefirstlineofdefenseagainstlosses.But
requiringthisshouldnothavemuchofanimpactontoday’sborrowingcosts,ifanyatall,foronesimple
reason:Guaranteefees(g-fees)chargedbyFannieandFreddietodayalreadyaccountforthiscostof
capital.FannieandFreddie,underFHFAdirection,havealreadyinitiatedaprocessofcomparingthecost
ofmortgagecreditimpliedbythemarketpriceforCRTsecuritieswiththeg-feestheycharge,andthe
FHFAbelievesthesecostsarealreadypricedin.Sothefirstlineofcapitalprotectionwerequiredoesnot
impactrates.
Second,thenextlineofdefenseagainstlossinoursystemistheentity-levelcapitalrequiredofthe
mutual.Butthisisamezzaninetrancheofrisk,notafirst-losssourceofcapital—itkicksinonlyafterCRT
isexhausted—sotheyieldhurdleiswellbelow10percent.Additionally,thesesharesaremutual
ownershipshares.Theirprimarypurposeisnottogeneratesubstantialprofitfortheendinvestorbutto
keepcreditenhancerssolventandoperationalforthelendingindustry.Butforthesakeofargument,
let’ssaythiscapitalbufferis2percentand,evenunderconservativestandards,requireda10percent
yield.Thiswouldincreaseratesbyjust20basispoints.(Notethatthisanalysisignoresthetargetreturn
FannieandFreddiealreadyearnontheirholdingoftheresidualrisktheyretaintoday,sothisoverstates
theexpectedmarketimpact.)
27
Finally,anMIFbackstopsthesystem,andtheFHFAwouldhavecontrolovertheamountitchargesto
capitalizethis.Let’ssayforthesakeofargumentthatthisfeewasinitiallysetat10basispoints.
Puttingittogether,then,wewouldhavea20-basis-pointincreaseinpricingfromentitycapitalplus10
basispointsfortheMIF.
However,wearemovingfromaFannieandFreddieMBStoaGinnieMBS.GinnieMBStradesatalower
yieldbecauseithasanexplicitfull-faith-and-creditbackingandfavorableBaselaccordcapitaltreatment.
Thismigrationactuallyreducessecondarymarketratesontheorderof15basispointssimplybecauseof
thisdynamic.Theincreaseinliquidityfromhavingonesecuritycouldmakethisratereductioneven
moresignificant.
Thus,evenlookingatthisconservatively,wearetalkingaboutatotalofa15-basis-pointincreasein
borrowingrates(20+10–15)phasedinovermanyyears.Again,thistousisaconservativeestimate
andassumesarequiredreturnonownershipsharesthatishigherthanwouldlikelyberequired.We
believethisisapriceworthpayingtoputtheissueofhousingreformtobed,asthealternative—relying
onfulltaxpayersupportandapotentialfuturecrisis—comeswithmanyunpredictablevariables.
Summary of Benefits Under Our Approach
CompetitioninLoanOriginationandCreditRiskSyndication
Thefirstandmostobvioussourceofnewcompetitionwouldbeanewmutualiftheoriginationindustry
caredtoapplytocreateone.Mortgageinsurersandmortgagerealestateinvestmenttrusts(REITs)are
otherpossiblesourcesofcompetition.If,forexample,theprimarymortgagemarketfeltthatFannieand
Freddieasmutualswerenotbeingasresponsivetotheneedsofthemarketastheycouldbe,itcould
petitiontheFHFAtoallowittocharteranewcorporation.Thesameruleswouldapplyforbothcapital
andaccessforthisnewentity.Itispossibletheindustrywouldnotfeeltheneedtodothis,asitwould
haveownershipcontroloftheenterprises.Butitisonewaythatwecouldallowanewentrantortwoto
breakanyduopolistictendenciesofsimplyhavingtwomegaenterprisesactingaslargemortgage
insurers.Asnotedearlier,acrucialcomponentofourproposalisthatFannieandFreddiemustoperate
inacompetitiveenvironmentwhereadisruptorcanenterandimprovethemarket.Mortgageinsurers
andmortgageREITscouldbesourcesofsuchdisruption.Ofcourse,theywouldneedtosatisfythesame
requirementsasanyothermutualcreditenhancer.
Theframeworkweproposepromotescompetitioninloanorigination,creditrisksyndication,and
mortgageservicing.Withloanorigination,thethousandsofmortgagelendersoperatingtodaywouldall
beabletooriginateandsellloansintoawell-functioningsecondarymarket.Moreover,theywouldhave
severalvehiclestoaccessthatmarket,notthelimitedsettheynowhave.
Creditriskwouldshiftfromtwobalancesheetstoperhapscountlessbalancesheets,therebygreatly
reducingsystemicriskofthefailureofasingleentity—FannieandFreddieareperhapsthesingle
greatestexamplesof“toobigtofail”intheentireAmericanfinancialsystem—andcreatingameaningful
private-capitalmarketfunctionformeasuringandevaluatingmortgagecreditrisk.Theexistenceof
28
severalhundredGinnieMaeissuersensuresnumerousoptionsformortgageservicingandforthe
management/oversightofsuchservicingthroughmasterservicingresponsibilitiesoftheissuers.
AlignmentofIncentives
Insomesense,theideaofmutualizationborrowsfromtheintellectualundercurrentsofriskretention,
whichwereinitiallyahallmarkofsomeofthemortgagereformsinDodd-Frankbuthavesincebeen
modifiedtoaccommodateamarketplacewheremortgagecreditrisk-takingfromtheprivatesectoris
stilllacking.ByrequiringlenderstoownsharesinthemutualsFannieandFreddieoranynewentrants
ortoretainapieceofriskinanycreditenhancementtheydothemselves,weareofferingaverysimple
waytoachievemanyofthegoalsofcreditriskretention—namely,theindustryhasastakeinthequality
oftheloansitproduces.
Thisisacriticalelementtoensuringthatg-fee-for-volumedynamicsthatproducelow-quality,poorly
underwrittenloansnolongerdistortthehousingsystem.
Byaligningincentivesthroughoutthehousingfinanceecosystem,wecanhavegreaterfaiththatthe
marketwillnotracetothebottomandsimplypassalongrisklikeahotpotato,ultimatelylandingatthe
feetofthetaxpayer.Andbecausethemarketforcreditriskwouldbeaprivatemarket,disputesamong
marketparticipantsregardingloanperformance,repsandwarrants,andsoonwouldberesolvedusing
normalcontractualandjudicialmechanismsandwouldnotbesubjecttoFalseClaimsActliability.
SimpleTransition
Thesereformswouldtakeonlyafewyearstoaccomplish.Aswehavepointedout,wearesimply
proposingchangestochartersthatbuildefficientlyoffamarketstructurethatiswellknownand
globallyaccepted.AndGinnieMaealreadyhastheoperationalcapacitytoadoptthesechangesin
relativelyshortorder.
Affordability Strip
InordertoenhancethesustainabilityofAmerica’shousingsystem,weproposethatallprivate-creditenhancedsecuritizationthatgoesthroughGinnieMaerequirea10-basis-pointaffordabilitystrip,which
wouldbegintobecollectedoncetheMIFwassufficientlycapitalized.
Thesefundswouldbeusedtofundahousingtrustfundwithstrongcongressionaloversight.Inour
forthcomingthirdpaper,wewilladvocateforthesefundstobeusedtoaugmentthebuildupofequity
forfirst-time,low-incomehomeowners;tohelpimproveaccesstoaffordablerentals;forcounseling
programsthathaveaproventrackrecordofloweringtherisksofdefaultandimprovingborrower
education;toimproveaccesstoshelterforsomeofAmerica’smostvulnerablefamilies;andother
purposes.
Conclusion
Weproposethreestepstoachievinglastinghousingfinancereform.One,amendtheGSEchartersto
makethemmutualsownedandoperatedbytheirseller-servicers.Two,amendtheGinnieMaecharter
tomakeitanindependentagencywithcontrolofitsownbudgetandtheabilitytoacceptformsof
29
creditenhancementotherthanjustFHA/VA/USDA.Andthree,amendtheFHFAchartertogiveit
authorityovertheentiresystemandapprovetheentryofnewcompetitorstotakeonmortgagecredit
riskinaregulatedmanner,whilemanagingaMortgageInsuranceFundthatbackstopstheentiresystem
asafinalbufferagainstemergencycongressionalbailouts.
Reformneednoteludepolicymakersanylonger.Perhapstrappedbythinkingthatreformmusteither
return,hatinhand,tothefailedmodelorrepresentarebuildingoftheentirehousingmarket
infrastructurefromthegroundup,wehavemadelittlelegislativeprogresssince2008.Butbyinstead
buildingonwhatweknowworksandbysimplyamendingthechartersofthelegsthatholduptoday’s
housingfinancestool,wecansubstantiallyreducetaxpayerrisk,improvemarketefficiency,keep
mortgageratesaffordableforallAmericans,introducecompetition,andfinallybuypeaceonthisthorny
andimportantpublicpolicyissue.
Next Steps
Thecomplexityofthemortgagesecuritizationprocess,includingthecomplicatedinterplayofcapital
rules,accountingrules,andtaxrules,plusliquidityrequirementsandcontractstoensuresatisfactionof
thoserequirements,meanthattheproposalherelikelyleavesunansweredsomeimportantoperational
questions.Moreover,theframeworkweoutlinedheremaybeunclearasregardscertainfeaturesofthe
marketplaceweenvision.Thuswelookforwardtoreceivingcommentsfrommarketparticipantsand
analystsontheframeworkandweexpecttorespondtokeyquestionsandissuesraisedbysuch
feedback.
Ourfirstpapermadethecaseforwhyreformisneeded,andthispapersetsforthourvisionfora
competitivemarketstructureforthesecondarymortgagemarket.Keyissuesstillremain.Insubsequent
paperswewilladdresshousingpolicy,includingmultifamilylending,underwritingstandards,and
fundamentalpolicyquestionsregardingaffordablerentalopportunitiesandpromotinghome
ownership,especiallyforlower-andmoderate-incomefamilies,first-timehomebuyers,andloansthat
maybemorechallengingtomake.Wewillalsoaddressanarrayoftopicsthatfallunderthegeneral
headingofthe“plumbing”ofourhousingfinancesystem,thatis,thelegalandoperational
infrastructureaffectingeverydaylendingdecisionsandcreditavailability.
30
About the Authors
MichaelBrightisadirectorintheMilkenInstitute’sCenterforFinancialMarkets.Brightworkedasa
traderofagencymortgage-backedsecuritiesandinterestratederivativesforsixyears,leaving
Wachovia’scorporateandinvestmentbankin2008attheheightofthefinancialcrisistocometo
Washington.HeworkedattheOfficeoftheComptrolleroftheCurrencyinthedivisionoflargebank
supervisionbeforejoiningtheofficeofSen.BobCorker(R-TN)andservingasaprincipalauthorof
S.1217,the“Corker-Warner”andlater“Johnson-Crapo”housingfinancereformbill.Brighthasalsobeen
involvedinthedevelopmentofseveralcreditrisktransferdealssinceleavingCapitolHill.
EdDeMarcoisaseniorfellowinresidenceattheMilkenInstitute.Priortothat,hewasa28-yearcivil
servant,culminatingwithhisroleasactingdirectoroftheFederalHousingFinanceAgencyfrom
September2009toJanuary2014.Therehedealtwiththechallengesofmanagingthemega-institutions
FannieMaeandFreddieMac.DeMarcocraftedthe2012FHFAStrategicPlanforEnterprise
Conservatorshipsandtheassociatedscorecardsandsetintomotionthecreditrisktransferandcommon
securitizationinitiativesthatunderpinadministrativeeffortstoday.
About the Center for Financial Markets
BasedinWashington,D.C.,theMilkenInstituteCenterforFinancialMarketspromotesfinancialmarket
understandingandworkstoexpandaccesstocapital,strengthen—anddeepen—financialmarkets,and
developinnovativefinancialsolutionstothemostpressingglobalchallenges.
About the Milken Institute
TheMilkenInstituteisanonprofit,nonpartisanthinktankdeterminedtoincreaseglobalprosperityby
advancingcollaborativesolutionsthatwidenaccesstocapital,createjobs,andimprovehealth.Wedo
thisthroughindependent,data-drivenresearch,action-orientedmeetings,andmeaningfulpolicy
initiatives.
©2016MilkenInstitute
ThisworkismadeavailableunderthetermsoftheCreativeCommonsAttribution-NonCommercial-NoDerivs3.0
UnportedLicense,availableatcreativecommons.org/licenses/by-nc-nd/3.0/
31