Tags: Private | mortgage | capital | MBS

Senate Explores Housing Finance Reform — Part II

By    |   Friday, 11 October 2013 01:31 PM

In Thursday's installment of the Perils of Housing Finance Reform, a Senate Banking Committee panel set forth the big-picture outline of what the industry wants from S. 1217, the bipartisan bill sponsored by Sens. Bob Corker, R-Tenn., and Mark Warner, D-Va., that the committee hopes to amend and pass by the end of the year.

On Oct. 1, in a hearing titled "Fundamentals of a Functioning Private Label Mortgage Backed Securities Market," the Senate Banking Committee, chaired by Tim Johnson, D-S.D., took a closer look at one aspect of the reform puzzle — how to meet the industry's demand for a revitalization of mortgage-backed securities (MBSs), which are created by assembling huge pools of mortgages and sold to investors by banks rather than by the so-called government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac.

The witnesses were Martin Hughes, CEO of Redwood Trust, the leading player in what is left of the private mortgage market, given the domination of mortgage finance by Fannie and Freddie, supported in conservatorship by the federal government; John Gidman, president of the Association of Institutional Investors who was representing a key market for the new generation of private-label securities (PLSs); and Adam Levitin, a professor at Georgetown University Law Center and an expert in mortgage finance.

In opening remarks Johnson noted that the percentage of the mortgage market represented by private capital has shrunk from 50 percent to 5 percent, and he repeated the demands of witnesses at the first hearing that reform preserve the so-called TBA (to be announced) market, which in turn makes possible the 30-year, fixed-rate mortgage that is central to the industry's business model.

After referring to the new administration request for $200 billion to fund the conservatorship of Fannie Mae and Freddie Mac, Sen. Michael Crapo, R-Idaho, the committee's ranking Republican, questioned the value attached to federal support and standardized documentation of mortgages that would be securitized, but he reiterated his commitment to work for a bipartisan bill.

Hughes set forth several reasons why the private mortgage market has shriveled, and he acknowledged that such a small market would not provide enough liquidity to support securitization. There is also a list of internal matters, such as establishment of best practices for the representations and warranties to be made to investors. For him these issues are solvable, but in fairness, his firm is eager to take interest risk, although not credit risk, in the mortgage market.

Gidman stated that as one who represents institutional investors to whom he owes a fiduciary duty, his firm cannot increase its commitment to the private market unless three concerns are addressed: the clarification of trustee fiduciary duties and putback requirements, the fact that new rules under Dodd-Frank impose liability on investors in MBSs for defects in the underlying mortgages and that some cities are threatening to use eminent domain powers to gain leverage to restructure underwater mortgages. (Putback requirements give trustees the power to force mortgage originators to buy back mortgages that fail to meet established standards and end up in default.)

Levitin supports the industry's reform agenda based on rebuilding the market for MBSs based on a government guarantee, but he is brutally realistic as to the limited ability of the private market to fill the gap between the potential demand for mortgages and its own limited capital. Even this capital "tends to flee when things get hairy," with the result that the government ends up on the hook. Levitin estimated the size of a functional mortgage market at $11 trillion and the potential of the private market at $500 billion.

Thus, even if one quibbles with Levitin's numbers, the overriding question, as always, is, who is going to pay to fulfill the remodeled version of the American Dream?

The most positive development is that there is an enormous amount of private capital on the sidelines, largely in the hands of oligarchs who also happen to be social Democrats. In other words, the United States now has a cohort of individual investors who have more discretionary income than does the federal government.

So if they believe that housing industry is worthy of support in order to enable Americans to hold mortgages before they have saved a substantial down payment, how much are they willing to bid for the privilege of taking over this risk?

Hopefully someone will ask this question as the hearings continue through the fall.

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On Oct. 1, in a hearing titled "Fundamentals of a Functioning Private Label Mortgage Backed Securities Market," took a closer look at one aspect of the reform puzzle — how to meet the industry's demand for a revitalization of mortgage-backed securities (MBSs).
Friday, 11 October 2013 01:31 PM
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