Tags: Zandi | housing | reform | finance

Senate Explores Housing Finance Reform — Part I

By    |   Thursday, 10 October 2013 01:23 PM

The Senate Banking Committee, chaired by Sen. Tim Johnson, D-S.D., began a series of hearings Sept. 12 that promise/threaten to last throughout the fall to consider the myriad issues and hear the large number of witnesses involved in the debate over legislation that is supposed to reconstruct the housing finance business five years after Fannie Mae and Freddie Mac, the dominant players in the business along with a handful of "too big to fail" banks, were placed under government conservatorship supervised by the Federal Housing Finance Agency, at an estimated cost of $200 billion.

These hearings might be thought of as an expedition into treacherous territory, such as an Amazon jungle, complete with carnivorous fish, quicksand and virulent disease, where it is easy to lose one's way and even the destination is uncertain.

Senators are already thinking that they may be running out of time to legislate, but they are bravely resolving to slog through this hearing process in the professed hope that they can agree on a bipartisan bill by the end of this year.

Ten senators, led by Sens. Bob Corker, R-Tenn., and Mark Warner, D-Va., have introduced S. 1217, a bill that seems to represent the views of industry leaders as to how to cut back on the "footprint" of Fannie Mae and Freddie Mac by bringing private entities, and some of their capital, into the market. The bill cries out for a name. "Corkercare" has a nice ring to it.

Witnesses at the initial hearing, titled "Essential Elements of Housing Finance Reform," were Julia Gordon, director of housing finance and policy at the Center for American Progress; Jerome Lienhard, II, CEO of SunTrust Mortgage who was representing a group of regional banks active in the mortgage business; Richard Johns, executive director of The Structured Finance Industry Group; and Mark Zandi, chief economist at Moody's Analytics.

"Structured Finance" is a term, perhaps a euphemism, to refer to the mortgage-backed securities (MBSs) that were highly rated by groups such as Moody's and Standard & Poor's but blew up during the period leading up to the 2008 episode of the ongoing financial crisis, as the housing boom collapsed.

The housing bust, and the built-in vulnerability of the financial system to untoward event in financial markets, contributed to the pressure for a blanket bailout of the too big to fail banks, securities firms and a leading insurance company, AIG, which took highly leveraged positions in this market because weak legislation, regulation and supervision, along with the knowledge that the industry holds considerable sway over government policymakers, invited them to incur risks large enough to threaten the global financial system, in pursuit of large short-term profits and compensation for management.

Zandi is an economist who is highly respected by senators of both parties and has advised the committee in drafting the bill. He hastened to point out that his group within Moody's is not the one that rated the securities that helped cause the episode in 2008.

The testimony of Lienhard can be dealt with readily in the interest of moving on to more interesting issues. On behalf of regional banks, he called for retaining what the industry calls the basic "plumbing" of mortgage finance. His second point was that when private capital comes into the mortgage market, this must be done "without reducing the global demand for [MBSs] and while providing competitive access for small and medium-sized institutions that serve millions of homeowners." What this testimony illustrated, which will become even more evident later, was that nearly everyone comes into this debate with some vested interest that "must" be protected in order for "reform" to proceed.

Next, it is useful to consider the demands of the structured finance industry "to ensure the continued liquidity of the TBA Market, which is the most efficient and cheapest mechanism to enable a mortgage consumer to 'lock in' the interest rate at the time when a mortgage loan is approved and thereby minimize the cost of borrowing." TBA stands for "to be announced," and to post as a demand that any market provide reliable liquidity is a huge burden to place on the market, especially since when liquidity dries up, the result can be another crisis episode and another round of bailouts.

The witnesses with the broadest outlooks were Gordon and Zandi. In the case of Gordon, this means that she has one of the most comprehensive sets of demands. She set forth a vision of "a well-functioning and responsible housing finance system that protects taxpayers," based on five core principles: liquidity, stability, transparency, access/affordability and consumer protection.

Putting aside the issue of consumer protection for the time being, because it invokes the domain of the controversial Consumer Financial Protection Bureau (CFPB), the other four principles all raise serious, inherent problems that were revealed through Gordon's own language.

Regarding liquidity, she said, "The system needs to provide a reliable supply of capital to ensure access to mortgage credit for both rental and homeownership options, every day and in every community during all kinds of different economic conditions and for large and small lenders alike." (Italics mine.) Experience shows that markets are treacherous, and not everyone can win all the time. So the question becomes, who is going to bail out whoever is losing at a particular time while at the same time protecting taxpayers. This looks like Mission Impossible.

As for the other principles, stability implies liquidity throughout an entire business cycle, something that the mortgage finance business chronically fails to deliver. Transparency requires a whole list of conditions, including clear and consistent documentation, regulators who accurately price assess and price risk, accountability of financial institutions for their capital positions and a secondary market that also embodies these characteristics, none of which has been established in the five years since the 2008 episode.

Gordon also called for these benefits to be provided to all creditworthy borrowers, but this almost becomes a moot point given all of the other flaws in the mortgage finance system.

This brings up the most interesting testimony, that of Zandi. One could probably design an entire finance course around this presentation, and some day, someone probably will. He laid out an initial group of goals that looked a lot like Gordon's. Then he set forth an additional list of "essential elements" that raise additional issues beyond the daunting problems implied in Gordon's demands, but to which most Gordon would agree to, so there are a lot of very difficult, perhaps intractable issues.

The essentials are: 1) so-called "catastrophic" backing by the federal government; 2) substantial private capital in a first-loss position; 3) varied sources of private capital; 4) strong regulation; 5) common platform for securitization; 6) competitive and independent mortgage guarantors; and 7) seamless transition from the present to the new system.

Despite the lengthy list of seemingly intractable problems raised by the endless demands of the industry groups behind this bill, the crunch will probably ultimately come when the time comes to pay the cost of the so-called reforms.

Zandi is the "go-to" guy for providing estimates of the cost that the higher capital requirements would add to what voters care most about — perhaps the only thing they care about — and that is the additional monthly mortgage payment.

Zandi's proposals call for a modest 5 percent capital backing based on historical data on losses that may no longer apply to this market. Corker's bill is based on 10 percent capital. If this change alone, assuming it could even be achieved, were to add, say, over $200 to the monthly mortgage payment, this might be entirely justified as the price of reform, but it is highly doubtful that policymakers and voters have processed this information.

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The Senate Banking Committee began a series of hearings that promise/threaten to last throughout the fall to consider the myriad issues and hear the large number of witnesses involved in the debate over legislation that is supposed to reconstruct the housing finance business.
Thursday, 10 October 2013 01:23 PM
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