Since the housing crisis, independent mortgage banks (IMBs) have become a key player in the housing finance system. IMBs originated more than 85 percent (PDF) of Federal Housing Administration (FHA) loans in the past year and fill an important gap in the market by lending to more households of color and borrowers with low and moderate incomes than banks do. But over the past few years, IMBs have experienced significant funding instability.
At the end of last year, major reverse mortgage originator and servicer Reverse Mortgage Funding (RMF) was forced into bankruptcy because of a lack of liquidity. It couldn’t fulfill a Ginnie Mae rule (PDF) that requires home equity conversion mortgage servicers like RMF to purchase loans from Ginnie Mae’s securitization pools once the balance on their loan is at least 98 percent of the maximum claim amount.
This scenario isn’t unique to RMF; it puts the entire reverse mortgage industry at risk.
Projected Required Buyouts for Ginnie Mae’s Home Equity Conversion Mortgage-Backed Security Program
Source: National Reverse Mortgage Lenders Association.
And it’s not limited to the reverse mortgage market. When loans in the much larger forward mortgage market are 90 or more days delinquent, Ginnie Mae servicers like IMBs must determine how to fund those loans. They have a choice between continuing to pay the pass-through interest rate on their Ginnie Mae mortgage-backed securities (MBS) pool or buying out the loans and using another funding source to fund the delinquent loan portfolio.
But without that additional funding source, IMBs don’t actually have both these options, which threatens their financial stability. The lack of funding puts them at risk now and at even greater risk during periods of economic instability like a recession, when alternative funding options become even more scarce. For example, during the financial crisis, warehouse line capacity dropped from $200 billion in 2007 to between $20 and $25 billion in 2009. The problem has intensified since IMB origination of government-insured loans has increased from 50 percent in 2007 to 90 percent today (PDF).
To ensure IMBs—which are critical actors in the lending market—don’t collapse during the next major recession, Ginnie Mae can consider guaranteeing short-term IMB funding.
How could Ginnie Mae guarantee short-term IMB funding?
Guaranteeing short-term IMB obligations would ensure adequate funding during times of market stress and would encourage banks to continue to lend to their nonbank counterparts. To relieve some of the pressure on IMBs, Ginnie Mae could do this by using federally backed mortgages as collateral.
Until now, Ginnie Mae has guaranteed only MBS. But section 306(g) of the National Housing Act (PDF) authorized Ginnie Mae, upon such terms and conditions as it may deem appropriate, to guarantee the timely payment of principal and interest on securities that are based on and backed by a trust or pool composed of mortgages that are insured or guaranteed by the FHA, the Rural Housing Service, or the US Department of Veterans Affairs.
Funding this program through guarantee fees paid by the issuers themselves would ensure taxpayers will not have to provide the funds to administer the program or cover any losses.
This funding vehicle could reduce the costs for IMBs to finance delinquent government-insured loans in their servicing portfolio and to fund new originations for two reasons:
- These Ginnie Mae–guaranteed securities would carry a zero-risk weight because they would have the full faith and credit of the government supporting the IMB obligations. This would make them more attractive to banks.
- Banks could use these securities to meet their liquidity requirements. These securities should be in a form that would ensure they could be bought and sold in the secondary market.
Ginnie Mae guaranteeing short-term IMB liabilities is a new concept that the evidence suggests could help stabilize the entire market. To ensure the solution will effectively help IMBs weather the next recession, policymakers should consider implementing it as quickly as possible, with the appropriate stakeholder input. Any policies will need to address the following questions:
- Who will be the paying agent on these securities (the paying agent makes the payments to the investors)?
- How will the securities be distributed in the capital markets?
- What will be the role of the Ginnie Mae issuer in the issuance, maturity processing, and tax reporting of the securities?
- How will small and medium-size issuers gain access to this security?
- How will Ginnie Mae hire the staff needed to manage the government guarantee of these securities?
- How will Ginnie Mae build out procedures to oversee issuers?
Guaranteeing the short-term obligations of servicers and originators of government mortgages would be a major step forward in creating funding stability among IMBs—and thus ensuring households of color, those with low incomes, and people seeking reverse mortgages don’t suffer most during a future recession.