Housing Finance for Journalists: Mark Zandi, Phil Swagel and the Milken Institute

8/13/2019 Housing Finance for Journalists: Mark Zandi, Phil Swagel and the Milken Institute

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A S H O R T P R I M E R O N T H E F U T U R E O F H O U S I N GF I N A N C E

M I L K E N I N S T I T U T E C E N T E R F O R F I N A N C I A L M A R K E T S

N A T I O N A L P R E S S F O U N D A T I O N

T U E S D A Y , D E C E M B E R 1 7 , 2 0 1 3

Mechanics of Finance: Housing Finance


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Overview2

Background 3

GSEs 7

Key Insights 12

Future Design 18 Transition 27


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-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

'96 '98 '00 '02 '04 '06 '08 '10 '12 '14

Housing Wealth Effect

Residential Investment

Total

From Headwind to Tailwind

Source: Moodys Analytics

Contribution to real GDP growth, %


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Old Housing Finance System

1: Bundle conforming mortgages into MBS and provide a guarantee- Socially valuable, but put taxpayers at risk from underpriced insurance.

2: Purchase those guaranteed MBS for the firms own portfolios.- Firms borrowed at low rates to invest in higher-yielding MBS. Essentially a hedge fund made possible by the implicit

government guarantee.

3: Affordable housing goals

4

Government

Banks &Other Lenders

Fannie Mae

+ Portfolio

Freddie Mac

+ Portfolio

MBS Investors

Debt Investors

Agency MBS

Conforming

Mortgages

Implicit

Guarantee

Agency Debt

4


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Background on Fannie & Freddie5

1: Bundle mortgages into MBS w/guarantee

2: Buy MBS for own portfolio investment

Enormous - $5.5 trillion in MBS & guarantees

Insolvent - losses ate up thin capital Under Federal conservatorship since Sept 2008

Now very profitable - $20 billion/year

Government owns 79.9 percent, has $187.5 billion senior preferredshares, and has received $55.2 billion in dividends.


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Mortgage Losses in Crisis6

Table 2: Residential Mortgage Loan Realized LossesBillions $

Total Debt Outstanding Losses as a %

2006 2007 2008 2009 2010 2011 2012 2006-2012 Year-end 2007 of Debt

Total 17.1 38.5 136.5 216.1 190.0 161.8 159.9 919.9 11,207 8.2

Government Backed 7.1 7.7 17.9 31.8 51.4 46.3 44.2 206.4

Fannie Mae & Freddie Mac 0.8 1.8 10.3 21.3 37.3 31.4 26.0 128.9 4,820 3.7

Fannie Mae 0.6 1.3 6.5 13.4 23.1 18.3 14.4 77.6

Freddie Mac 0.2 0.5 3.8 7.9 14.2 13.1 11.6 51.3

Federal Housing Administration 6.3 5.9 7.6 10.5 14.1 14.9 18.2 77.5 449 17.3

Privately Backed 10.0 30.8 118.6 184.3 138.6 115.5 115.7 713.5

Mortgage insurers 1.5 6.9 10.8 9.6 6.6 6.0 6.0 47.4

Depository Institutions 2.7 7.3 35.0 54.9 48.2 35.3 33.3 216.7 3,729 5.8

Private Label Mortgage Securiti 5.8 16.6 72.8 119.8 83.8 74.2 76.4 449.4 2,209 20.3

Subprime 5.6 15.5 55.9 71.6 39.0 34.7 35.5 257.8

Alt-A 0.2 0.9 11.3 28.0 24.0 20.5 20.1 105.0

Option ARMs 0.0 0.2 5.2 17.9 17.4 14.8 16.5 71.9

Jumbo 0.0 0.0 0.4 2.3 3.4 4.1 4.3 14.6

Note: Securitized HELOC 0.2 1.5 5.1 5.1 3.4 2.1 1.6 18.9

Sources: Fannie Mae, Freddie Mac, HUD, FDIC, Federal Reserve Board, Moody's Analytics


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Crisis Impact on Mortgage Market

Source: John Krainer, Recent Developments in Mortgage Finance, FRBSF Economic Letter, Oct 26, 2009

7


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Overview8

Background 3

GSEs 7

Key Insights 12



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Benefits of the GSEs9

Borrowers benefit from lower interest rates

Liquidity in secondary markets

Implicit (now explicit) subsidies from federal guarantee kept interest rates abit lower

Backed by federal guarantee, GSEs continued to finance mortgages indepths of financial crisis

GSE securities provide a mechanism for the Fed to implement

extraordinary monetary policy and subsidize mortgage interest rates

Some affordable housing subsidies (even if not well targeted)


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Value of Government Backing10


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Principles for GSE reform12

1. Support liquidity in secondary market

2. Avoid systemic risks

3. Protect taxpayers

4. Help homeowners

5. Encourage beneficial innovation

6. Promote transparency

7. Recognize relative strengths of government agencies andthe private sector


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Overview13

Background 3

GSEs 7

Key Insights 12



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Key Insights14

Agreement on many aspects of housing finance reform

Private capital at risk ahead of a secondary government guarantee

Government share shrinks as private sector takes on housing risk

No GSE portfolios or affordable housing goals; instead explicitsupport for affordable housing (owner and rental)

Foster competition in mortgage origination and guaranty

Certainty on housing finance system will help housingtoday.

Transition steps are the same for all plans beingconsidered.


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1. Investment portfolios? No.15

Portfolios expose taxpayers to large risks (in essence,government backstops a hedge fund)

Portfolios provide only limited benefits to borrowers (undernormal conditions)

Portfolios are an invitation to non-transparent policy creep

(pressure from legislators)

Transition: Need to manage or sell the existing $1.5 trillionportfolio


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3. Affordable housing mission? No.17

Past efforts had limited success, lack of oversight, andcontributed to GSE collapse

FHA is better suited to this mission

Spending or tax programs would be more transparent

Policymakers could levy an explicit fee on GSE activities tofund affordable housing programs


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4. Backstop mortgage market? Yes.18

Likely inevitable. Guarantee is latent.

Fed & Treasury intervened in 2008 Money Markets

GSE/government guarantee has boosted liquidity in thesecondary mortgage market

Government has unique ability to insure against

macroeconomic shocks such as a nationwide decline inhome prices

Key question: What design?


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Overview19

Current State of Public Finance 3

Municipal Bond Market Principles 8

Key Insights 12



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Treasurys Potential Options20


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Design Options21

Government-sponsored enterprises

Explicit government guarantee & associated fee

Are two enough?

Government agencies (like FHA / GNMA ) Agencies guarantee and securitize MBS

Other GSE activities privatized

Mixed model

Government agency sells MBS guarantees Private firms, including GSE successors, securitize mortgages

and purchase guarantees


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Summary of the Plan22

Fully private. Former GSEs have no special status.

No portfolios. Existing portfolios wind down.

Explicit guarantee. Government guarantees MBS of conforming mortgages againstdefault. The guarantee kicks in after shareholders are wiped out.

Higher insurance premiums. The former GSEs pay a premium that covers expectedcosts. But government still underprices insurance, so

Entry & competition. Other firms can purchase the guarantee and securitize

confirming MBS. Competition reduces risk and increases benefits for borrowers.

No affordable housing requirements. Affordable housing is pursued through othermeans (e.g., FHA). A tax on conforming MBS activities finances these subsidies.


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Future Mortgage Finance System24

"A Pragmatic Plan For Housing Finance Reform," by Ellen Seidman, Phillip Swagel, Sarah Wartell and Mark Zandi.Prepared by Moody's Analytics, the Urban Institute and the Milken Institute, June 19, 2013. Available at http://www.milkeninstitute.org


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Private Capital25

Private MBS guarantors are not backed, explicitly or implicitly, by the government.

Guarantors purchase catastrophic reinsurance from the government for the benefit of MBSinvestors, paying a g-fee to the government for this insurance.

Several sources of private capital bears the bulk of the credit risk in housing, taking losses

ahead of the government and protecting taxpayers.

At the level of individual mortgages, private capital sources include homeowners downpayments and the capital of any private mortgage insurers.

At the level of the mortgage-backed security, capital sources would include, but not be limitedto the capital of the MBS insurer and the capital put at risk by global investors who take onhousing risk from MBS insurers.

Entry of new sources of private capital is essential to provide for competition in the newhousing finance system.

FMIC ensures that institutions of all sizes have access to the housing finance system.



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Market Access Fund27

R&D Fund to support research, development and testing of innovation in products,underwriting, and servicing. Examples include mortgages with reserve accounts; equitysharing; and new housing counseling models.

Credit Support Fund to provide capital ahead of the secondary guarantee for activities such as

bi-weekly payment mortgages; small rental properties; manufactured housing; assisted livinghousing; and more.

Capital Magnet Fund to support affordable housing for low-income families. Competitiveawards to CDFIs and non-profit housing developers, with at least $10 of outside funding forevery $1 granted.

National Housing Trust Fund to support the production, preservation, and rehabilitation ofrental housing for low income families.



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Criticisms28

Maintains government role

Hard to price this insurance

Anti-housing because mortgage rates go up (Another) sop to Wall Street lets them go into

securitization and they will engineer the governmentguarantee to cover the rest of their activities

Stress on definition of a conforming loan


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0 25 50 75 100 125 150

Pre-housing crash

Current system

Nationalized, 5% capital

Corker-Warner, 10% capital

PATH privatized system

The Cost of Housing Finance Reform

Source: Moodys Analytics

Minimum cost, bps


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Overview30

Current State of Public Finance 3

Municipal Bond Market Principles 8

Key Insights 12



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Transition31

Low-income housing subsidies

Multi-family activities

Setting appropriate premiums

Definition of conforming mortgage Future of private mortgage insurance

Future of the FHLBs

Wind down of existing portfolios How to bring in private capital


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Policy Levers32

Higher guarantee fee

Reduce quantity of government insurance capacity

Require increased private capital

Narrow scope of guaranteed mortgages

QUESTION: Why were proponents of

reform called anti-housing in the past?


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Policy Levers33

Policy Lever What policy would entail ImpactPrice for government insurance

on MBS (guarantee fee)

Charge a higher price for the

government guarantee on MBS.

Higher mortgage interest rates as

the increased g-fee is passed

on to home buyers

Amount of government

insurance capacity

Auction off a limited amount of

government insurance on MBS.

Offering to insure only a limited

amount of conforming mortgages

would increase the guarantee fee

(as set in an auction) and thus

interest rates.

Definition of conforming loans

that qualify for a guarantee

Lower the loan limit for

conforming loans or otherwise

narrow the scope of mortgages

that qualify for the guarantee.

Will foster a non-guaranteed

market by forcing some

mortgage loans outside the

conforming standard. These non-

guaranteed loans could face

higher interest rates (they will

not pay the insurance but will not

benefit from the guarantee).

Amount of private capital

required in front of the

guarantee

Require securitizing firms to

arrange for private capital to take

losses before taxpayers.

Limits government risk but

mortgage interest rates will rise,

reflecting the cost of the private

capital.


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Housing Finance Reform Timeline34

Year 1 Year 2 Year 3

FMIC and MAF fundsoperational

FF portfoliossold off

MERSreforms

Securitization platformestablished

Establish MAFand set fee

MBS insurance

charters granted

FF assets soldto MBS insurers

FF gfees toFMIC fund

FF conservatorshipends

Private labelRMBS marketrestarts

FMIC setsG fees

Private labelRMBS marketfully operationalFMIC fund

established

FHFA reconstitutedas FMIC

QM, QRM, Basel IIIrules in place

FF securitizationmoved to new platform

Set MBS servicingstandards on platform

Requires Congressional Authorization

MBS insurancestandards set



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Timing and Politics35

What will drive forward reform?

Fannie & Freddie are making $20 bn per year inprofits. What incentive does this give the

government? What are the reasons to move forward with reform?

Why not insist on a fully private system?

When do you expect reform to happen?

Documents

Housing Finance for Journalists: Mark Zandi, Phil Swagel and the Milken Institute