Why Keep The GSEs Undercapitalized?

Posted by Patrick Barnard on December 15, 2014 No Comments
Categories : Residential Mortgage

The Community Mortgage Lenders of America (CMLA) recently called on Treasury Secretary Jack Lew and chief government-sponsored enterprise (GSE) regulator Mel Watt to take immediate action to cure the undercapitalization of GSEs Fannie Mae and Freddie Mac.

In a Dec. 10, 2014, letter to the Federal Housing Finance Agency director and the U.S. Treasury secretary, the CMLA requested they immediately restructure the payment terms embedded in the Preferred Stock Purchase Agreements (PSPAs) to enable the GSEs to retain more of their net earnings and rebuild their currently insufficient capital positions.

CMLA Chair Paulina McGrath says that there is no point in keeping GSE guaranty fees at today's historically high levels to generate large profits if those same profits do not make the GSEs more financially stable. ‘Making mortgage money more expensive is simply locking many borrowers out of the market and serves no benefit to the GSEs. Renegotiating the PSPA now is a common-sense approach to ensuring the safety and soundness of the GSEs.’

According to the CMLA, the GSEs financial resurrection seems to be benefiting the U.S. Treasury at the expense of low- and moderate-income borrowers who simply cannot afford the high GSE fees. Collectively, the GSEs have normalized net earnings at approximately $20 billion to $25 billion a year. Nevertheless, the Treasury continues to collect quarterly profits at levels never imagined under the initial PSPA.

The vast majority of the GSE fee revenue is being passed onto the U.S. Treasury, leaving current GSE capital levels far too low to address the risk of even a moderate downturn. This undercapitalization leaves the GSEs dependent upon the U.S. Treasury for additional assistance in the event of adverse financial developments. Such a situation benefits neither the mortgage and housing markets, nor the consumers they serve.

This situation is created by the terms of the GSE payment agreement with the U.S. Treasury in exchange for the $190 billion GSE bailout. Currently, the GSEs must remit 100% of profits, which precludes building capital. To date, Treasury has been more than repaid. The GSEs have paid a total of $220 billion and must continue to remit all profits.

The Treasury can – and should – take immediate corrective action to cure the undercapitalization of the GSEs. According to the CMLA, there is neither a need nor a rational reason to wait on Congress to act, particularly because GSE reform legislation is far from certain.

‘Mortgage bankers have now joined the civil rights groups and community banks in asking for this important, common-sense change,’ McGrath says.

The alternative, and the less preferable, approach is to lower the GSE guaranty fees. This would at least remove an unnecessary tax that locks many home buyers out of the market.

The CMLA urges a more rational approach to supporting the U.S. housing market. The GSEs financial health historically furthered homeownership rates, and there is no rationale for risking their ability to do so now.

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