Tags: capital | mortgage | banks | private

Senate Builds Consensus on Mortgage Reform

By    |   Tuesday, 21 May 2013 01:45 PM

On May 14, the Senate Banking Committee's Subcommittee on Securities, Insurance and Investment, chaired by Jon Tester, D-Mont., held a hearing titled "Returning Private Capital to Mortgage Markets," and then, in case anyone missed the point, and because a trend in title inflation has evidently taken hold throughout the culture, the title continued, "A Fundamental for Housing Finance Reform."

The hearing included four private-sector witnesses, each with close ties to what I call the "Housing-Industrial Complex," who gave their views on what a "reformed" housing finance system would look like.

The senators showed no evidence of appreciating the irony in going for advice on how to reform a system that failed spectacularly during the 2008 episode of the ongoing financial crisis for advice on how to proceed. One would hope that anyone who had anything to do with the "too big to fail" banks and the mortgage finance industry would be barred from the building, but that would be asking too much.

Still, the industry is exploring the realm of the fantastic as it propagates a view that the main oversight in 2008 was to confer an implicit government guarantee on mortgages and mortgage-backed securities. This time it must be explicit, but this is justified by the conceit that private capital will be part of the reformed model, and all of this is, of course, for the purpose of ensuring the enduring availability of affordable credit for long-term, fixed-rate mortgages.

I would suggest that the imperative is to restore the flow of fees to the originators of mortgages housed mainly in a handful of too big to fail banks and to the securitizers of mortgage paper by Wall Street affiliates of many of the same banks.

In his opening statement, Tester repeated the theme of recent hearings on this subject that keeping Fannie Mae and Freddie Mac in perpetual conservatorship is not an option. A cynic would respond that this has already occurred, as the conservatorship approaches its fifth anniversary. He concluded with the exhortation that the time for action is now for a bipartisan solution to the open questions about the future of the housing government-sponsored enterprises.

Among the four expert panelists, each attached qualifications to his vision of reform that showed his proposal to be a thinly veiled variation of the existing duopoly, perhaps with the addition of one or more players, such as Wells Fargo.

Mark Willis, a resident research fellow at New York University who was previously with JPMorgan Chase, insisted that measures to require private capital ahead of a government guarantee should only be imposed after extensive testing of the effect on the availability and affordability of long-term, fixed-rate mortgages with a 30- to 90-day rate lock.

Andrew Davidson, president of consulting firm Andrew Davidson & Co. who formerly worked for Merrill Lynch, observed that due to poor performance of the underlying mortgages packaged as private-label mortgage-backed securities purchased as low-risk investments, many of them are now subject to credit risk. He advised that such devices as senior subordinated notes and credit-linked securities could be used to reduce risk to taxpayers without undue cost to borrowers "if properly structured." This would entail an array of conditions, including exemption from Securities and Exchange Commission registration. He asserted that Fannie Mae and Freddie Mac should be "transformed from what they are to" a benign cooperative structure.

Philip Swagel, a professor of international economic policy at the University of Maryland who advised President George W. Bush's Treasury on the Troubled Asset Relief Program (TARP), suggested that various policy levers be employed gradually to reduce the government's role in the mortgage market by bringing in private capital. But he made the Orwellian/Leninist proposal that "to reach an outcome of a fully private market, at first the housing finance system must transition through a series of intermediate steps, in which the government guarantee recedes. There's a sense in which it's useful to formalize the government guarantee, so that it can recede."

Finally, Robert Van Order, chair of the department of finance at George Washington University who was formerly with Freddie Mac, acknowledged that the nature and role of private capital would be "quite ambiguous." His favorite device for reducing the risk to the government is something called "contingent capital."

I would point out that the problem with contingent capital is that it is contingent. The principle should be that if banks want to be in this risky business, which can be lucrative for a time when conditions are favorable, then turn adverse, leading the banks to seek government bailouts, they should be subjected to capital requirements of the type advocated by FDIC Vice Chairman Thomas Hoenig of at least 15 percent tangible capital.

However, history has shown that the financial sector has resisted the application of higher capital standards and stronger risk management controls, including the placement of risky trading activities in separately capitalized subsidiaries, at every turn.

As this was being written, Sen. Elizabeth Warren, D-Mass., sharply questioned Treasury Secretary Jack Lew as to why the Treasury has opposed legislation to break up the largest banks. Lew responded that the regulators are going to proceed with the Dodd-Frank regulations. "There have been a lot of calls for legislation, and now is not the time to be enacting big changes to Dodd-Frank or to the regulatory system," he said.

That also appears to be the case with regard to so-called mortgage finance reform. It appears that the industry intends, with the complicity of Congress, to be content with pushing the reset button and proceeding as before until the next inevitable crisis and bailout.

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On May 14, the Senate Banking Committee's Subcommittee on Securities, Insurance and Investment held a hearing titled "Returning Private Capital to Mortgage Markets," and then, in case anyone missed the point, the title continued, "A Fundamental for Housing Finance Reform."
Tuesday, 21 May 2013 01:45 PM
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