A trio of Democratic congressmen who serve on the House Committee on Financial Services next week will formally introduce a ‘middle ground’ housing finance reform proposal that uses private-sector market forces to appropriately price risk while putting the scale and security of a government guarantee behind the program.
The alternative plan by Reps. John K. Delaney, D-Md., John Carney, D-Del., and Jim Himes, D-Conn., a draft of which was unveiled in January, would establish a new government reinsurance agency that would back all qualified mortgages, but at the same time, all issuers would be required to maintain a 5% private capital reserve to cover first losses.
As per the draft proposal, after securing the minimum level of private capital, issuers would be able to securitize their mortgages through Ginnie Mae. Separately, private insurers would be invited to contract with Ginnie Mae and share the reinsurance pricing and risk, with the private insurer assuming a minimum 10% on a pari passu basis. In addition, the bill would return government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac back to the private market – thus ending the government's ‘monopoly’ in the mortgage business – however, the companies would no longer write guarantees and would only serve as issuers.
‘We're going to introduce [the final bill] the week after the Fourth of July holiday,’ Rep. Delaney said during an interview with MortgageOrb, adding that the congressmen are currently working hard to revise the bill's text and that it should have a name and number by then. (However, Rep. Delaney's communications director later told MortgageOrb that the timing of the introduction of the bill was still somewhat uncertain.)
Currently, there are several proposals in the House and Senate – each prescribing a slightly different approach to the challenge of housing finance reform. Arguably, the most popular of these is the amended Housing Finance Reform and Taxpayer Protection Act of 2014, introduced by Senate Banking Committee Chairman Tim Johnson, D-S.D., and Ranking Member Mike Crapo, R-Idaho, which builds on last year's proposal by Sen. Bob Corker, R-Tenn., and Sen. Mark Warner, D-Va. Then there is the Protecting American Taxpayers and Homeowners (PATH) Act of 2013, introduced by Financial Services Committee Chairman Jeb Hensarling, R-Texas. And then there is the Housing Opportunities Move the Economy (HOME) Forward Act, also known as the Waters draft bill, introduced earlier this year by Rep. Maxine Waters, D-Calif.
Should the Delaney-Carney-Himes proposal be adopted, it would likely need to be reconciled with one or more of these other proposals – not a simple task considering that each prescribes a slightly different structure for what is a very complicated market.
Rep. Delaney said his proposal is a ‘good middle-ground solution’ that addresses many of the flaws in the other proposals. What's more, he said he thinks his bill has a better chance of gaining bipartisan support and making it out of the Republican-controlled House.
‘I think the problem is that, as usual, we're stuck in a bit of an ideological track, which is the House version [PATH Act] wants the government out – and the Senate version [Johnson-Crapo] has issues that anger people on both sides – mainly that the government guarantee won't be priced appropriately. People see that structure and see shadows of Fannie and Freddie.
‘That's why I think our proposal has a lot of merit – because we realistically allow for a government guarantee to stay in housing, but we insist on it being priced in the private market,’ Delaney added. ‘I think the housing debate is looking for a compromise – and I think our bill could be that compromise – not so much in terms of watering down the two other bills and mashing them together, but, rather, a new and innovative approach that appeals to each side's principles.’
When asked whether or not the introduction of this bill makes the task of housing finance reform more difficult – simply because there are so many proposals on the table – Delaney says he and his colleagues are mostly concerned with coming up with an alternative proposal that will gain Republican support, as opposed to how the bills will be reconciled.
‘I think strategically we're focused on working with our Republican colleagues to bring something out of the House,’ he said. ‘I think [Committee] Chairman [Jeb] Hensarling deserves a lot of credit for having the first proposal fully baked and passed by committee, but I think there is a fundamental issue with that proposal which will make it harder for it to move out of the House – which is that it removes the government guarantee. What we're hoping is that the private market discipline that is embedded in how we introduce the guarantee will appeal to both the chairman and his conservative colleagues – that this is an appropriate way for the government to be engaged in housing.’
Regardless of which proposal is adopted, one of the main concerns running through the mortgage industry is that the transition to a new housing finance system could be costly and may ultimately impact credit availability. This is a huge concern for an industry that is still struggling to help the housing market back on its feet following the 2008 crash.
Delaney, however, said the industry's fears that GSE reform will be ‘too disruptive’ are ‘way overstated.’
‘I think markets adapt much more quickly than people believe,’ Delaney said. ‘The mortgage industry likes the way it works now, not because it's a matter of policy but because they understand it, they know what numbers to look at on the screen, and they know what forms to fill out, and they don't want that to change because it's just a pain for them. I think we need to consider that in the context of the size of this market – this is a trillion dollar a year market – and we shouldn't just let some paperwork issues – and forcing the market to think differently – disrupt the implementation of meaningful policy. There are plenty of incentives for this market to come up with a new system and get up to speed.’
So how does Delaney respond to those originators who say that any GSE reform will invariably make lending more expensive for consumers because it requires the lenders to upgrade systems and train people?
‘Who cares? I don't believe that,’ he snapped. ‘Listen, I was in the lending business – and I can tell you that the big operators will figure it out and reorganize their business accordingly. They have way too much financial incentive not to do that.’
On the other hand, Delaney conceded that a proposal that removes the government guaranty completely and hands that responsibility over to private capital practically overnight could potentially have disastrous consequences.
‘Turning the second largest fixed income market in the world immediately over to the private market without natural organic transition to more private capital, sure, you could get that wrong,’ he said. ‘But as long as your fundamental building blocks remain sound, and you've created enough supply and demand balance in the market so it operates efficiently, these operational concerns that people raise, I think they are so overstated.
‘If we're creating a slightly different way of aggregating mortgages and securitizing them, can you imagine going to the manager of a large bank and saying 'We're not going to participate in the second largest fixed income market in the world because we can't build new systems and reorganize our teams?' You'd get thrown out of the room,’ Delaney said. ‘Of course, we're going to build in transition – we have to. So these concerns about market transition – these are coming from people who fundamentally want the status quo – they just want to throw a wet blanket on any reform.’
So does Delaney feel his proposal is the least disruptive, as it keeps the government backstop in place and keeps Fannie and Freddie more or less intact?
‘Well, what [Fannie and Freddie] are going to do is going to be very, very different because they won't be able to write guarantees – they're only going to be issuers,’ he said. ‘You know, this is going to help the small issuers – our system will be better for that. When you talk to a lot of the big players in the market, everyone thinks this can be transitioned pretty easily.
One interesting aspect to the Delaney-Carney-Himes alternative is that it gives investors who continue to hold shares in Fannie Mae and Freddie Mac a chance to recoup on those investments, as the GSEs will be returned to the private market. In June 2013, a group of private shareholders of Fannie and Freddie filed a complaint against the U.S. government claiming that when the GSEs were placed into conservatorship in September 2008, it obliterated the value of their common and preferred stock.
The complaint, filed by Hagens Berman Sobol Shapiro LLP and Spector Roseman Kodroff & Willis PC (SRKW) in the U.S. Court of Federal Claims, seeks $41 billion in damages. It claims the government owes shareholders who suffered financial losses as a result of the takeover ‘just compensation under the Fifth Amendment.’
Meanwhile, Fannie and Freddie continue to post record profits after returning to the black last year.
‘We're not commenting on any of the investors' claims – because that will play out on its own path, that is, if we let Fannie and Freddie stick around,’ Delaney said. ‘They're going to be in a completely different business, fundamentally. If Fannie and Freddie are worth anything, after all is said and done, that's fine – then it will get distributed the way it will get distributed.’
Delaney said that if his bill is adopted ‘as is,’ it would take several years for the transition to take place.
‘I think you could get started on it within six months – and I think it could happen pretty quickly,’ he said, adding that it could take far less than the five years suggested under other proposals.
‘Effectively what we're doing is we're providing a government guarantee – but we're doing it through a new agency,’ Delaney emphasized. ‘It's a fairly simple process to look at pools of mortgages, decide if they're eligible and then write a government guarantee. The complex part of it is creating the mechanism for the government to offload a piece of its exposure onto the private market. What we're looking at there is effectively the reinsurance model – which is effectively what the government is doing today: providing insurance against defaults.’
To learn more about the original draft proposal, click here.