After Congressman Mel Watt was sworn in as the Director of the Federal Housing Finance Agency on January 6 of this year, he offered a few words of thanks and assurance and then promptly disappeared from the scene. This week, Director Watt broke the silence, giving his first major public speech as director. For the remarks, see here. Signaling the importance and range of his inaugural remarks, Watt used them to announce a revision of the agency’s Strategic Plan and Scorecard, the policy documents that together provide both the vision of the agency and a set of incentives to push the leadership of Fannie Mae and Freddie Mac (the enterprises or the GSEs) to fulfill that vision.
In February 2012, the FHFA released its first public strategic plan, laying out three broad strategic goals for the enterprises, in order of priority: building a more efficient infrastructure for the mortgage market, contracting the market presence of the GSEs, and maintaining broad access to credit and relief efforts for those struggling with their mortgages. See here.
Every year since then, the FHFA has released a scorecard that provides the enterprises with a set of objectives intended to further each of these broader goals. See here. How the enterprises perform in meeting those goals determines 15 percent of the compensation of the senior executives. The scorecard is no empty policy gesture, but an indirect mandate for the leadership of the enterprises.
It is thus also a useful vehicle for a new director to lay out a new vision for the enterprises. And Director Watt uses the opportunity admirably, laying out a vision for the GSEs that is cogent, comprehensive and markedly different from that of his predecessor.
Like former FHFA Director Ed DeMarco, Director Watt presents a plan organized around three broad goals. Watt’s list, in order of priority:
- Maintain foreclosure prevention efforts and credit availability for new and refinanced mortgages.
- Reduce taxpayer risk through increasing private capital in the mortgage market.
- Build a new securitization infrastructure for use by the enterprises and adaptable for eventual use by others in the secondary mortgage market.
While these goals appear quite similar to those of DeMarco, even at this level of generality, there are two important differences that signal a significant shift in the agency.
First, the goal of maintaining adequate options for borrowers has gone from the bottom priority, accounting for 20 percent of the overall scorecard grade, to the top, accounting for 40 percent. And second, the subsequent goal is no longer contracting the enterprises' footprint in the market, but reducing the risk to the taxpayer. Director DeMarco had pushed a contraction of the GSEs’ market presence as a means to "crowd in” private capital, under the then widely held view that the government’s presence in the market alone was blocking the return of a healthy private label securities market. Recently, economists and industry experts have come to a different view: that there are additional barriers to the return of the PLS market, and that if policymakers shrink the GSE footprint before those barriers are removed they will also shrink the housing market. See here. The new regime at FHFA appears sympathetic to this latter view.
Together these two shifts tell a broader story: Director Watt has signaled that he will turn from focusing on the enterprises as institutions in intentional decline to institutions that should be better prepared to form the core of our system for years to come. This shift in focus ripples through the many decisions announced in the speech and signals a watershed moment in the brief history of the agency.
Below I walk through the policy steps under each of the three broad goals of the revised strategic plan.
Goal One: Maintaining adequate options for borrowers
Single-family access to credit
Director Watt announced several steps to increase access to credit for those looking to purchase a home. The most important by order of magnitude are actions that will reduce the uncertainty over when and why the enterprises will force a lender to repurchase a loan due to underwriting mistakes (put-backs). As has been discussed often over the last year, the lack of clarity over these rules has led lenders to apply credit overlays, dramatically reducing access to lending through the GSE-backed channels.
Director DeMarco took steps to address this last year, introducing a provision releasing lenders from their liability for non-fraudulent underwriting miscues if a borrower remained current on their loan for 36 months. While a sunset on put-backs can be an effective way to address the uncertainty, by narrowing the put-back focus to loans that are much more likely to have been flawed when made, the provision was too loose as implemented to provide the certainty needed. Director Watt is thus taking several steps to strengthen the changes.
First, lenders will receive a formal letter relieving them of all liability for non-fraudulent underwriting miscues if either of two things happens:
- a borrower has no more than two 30-day delinquencies over the first 36 months after a loan has been purchased by the enterprises, and no 60-day delinquencies; or
- the enterprises have performed a quality control check on the loan and found no defects, irrespective of the age or performance of the loan.
Second, Director Watt has directed his senior team and the enterprises to work closely with lenders to better define what liabilities survive the sunset. Currently, claims of fraud and some data mistakes are exempted from the sunset, but these categories are so loosely defined that the exemptions undermine much of the certainty that the sunset is intended to provide.
Third, when a mortgage insurer withdraws coverage on a loan, the loan will no longer automatically be put back to the lender, as has been the practice to date. The enterprise will review the loan file and if it finds that the lender has complied with enterprise underwriting requirements, it will give the lender the option of finding another mortgage insurer to provide the insurance coverage for the enterprise or provide that coverage itself.
While these steps may appear technical in nature, they should give lenders more comfort to lend to an expanded group of credit-worthy borrowers, many of whom are locked out of the market today because lenders are not sure if the enterprises will guarantee their loan, should the borrower default. For more on this complex issue, see here and here.
Finally, Director Watt has also declined to follow Director DeMarco’s intended course in shrinking the maximum single-family loan size eligible for support from the enterprises. Another central tenant of the prior regime’s effort to contract the footprint of the enterprises, this would have directly contradicted the new regime’s insistence on focusing on access and liquidity, and run counter to its skepticism that reducing the footprint of the enterprises will contribute to the return of private capital.
Improving options for struggling borrowers
On the refinancing front, the enterprises will pursue a targeted effort to reach those underwater borrowers who would still stand to benefit from the Home Affordable Refinance Program (HARP). Note that the FHFA is not planning to change the terms of the program, only the enterprises’ outreach. In particular, FHFA is not heeding the call of some advocates to extend the date (June 1, 2009) by which one’s loan must have been originated in order to qualify. It has reached the conclusion shared by others that too few borrowers would benefit from the change, as few who originated loans after that date have rates sufficiently lower than today’s to make it worth the cost of refinancing. See here.
The agency is also launching what it is calling the Neighborhood Stabilization Initiative (NSI) with the enterprises and the National Community Stabilization Trust. The group will begin NSI with a pilot program in Detroit, in which they pursue programs that provide a deeper and more aggressive range of pre- and post-foreclosure strategies. They will take the lessons learned from this pilot and expand the program to other distressed communities.
Access to credit for multifamily developers
In keeping with his broader strategy to prepare the GSEs for wind-down and transition, Director DeMarco mandated the rapid contraction of the enterprises’ multifamily business lines. And in keeping with his broader pivot away from contraction and towards improving the stability and efficiency of the system as it stands, Director Watt is not only locking into place the current limits on the size of the enterprises’ multifamily business, but removing lending for affordable multifamily housing from the calculation of those limits. This functionally reverses the decline of the enterprises’ multifamily business, and pushes it more aggressively into underserved communities facing shortages of affordable rental housing, a problem growing increasingly acute in many areas of the country. See here.
Goal two: Reducing risk to the taxpayer
As mentioned, here the FHFA is undertaking a critical shift in approach, from focusing on bringing private capital back by shrinking the GSEs' footprint, to bringing private capital back within that footprint. This shift has the advantage of reducing taxpayer risk without compromising access, and is thus aligned with the agency’s first goal.
To that end, the FHFA has taken steps to deepen and diversify the credit risk transfers begun under DeMarco’s tenure. It will triple the annual volume to be syndicated, from $30b per enterprise to $90b, and add incentives to develop an entirely new array of structures through which the risk will be shared. Increasing the amount of shared risk is, of course, valuable in reducing the risk to the taxpayer, but expanding the variety of structures through which it is shared is also going to be critical to better understanding how best to reform the GSEs over time. Recall that many models for long term reform, including the Johnson-Crapo bill currently before the Senate Banking Committee, involve the government taking on the role of a re-insurer, which just means insulating the taxpayer behind a thicker and thicker layer of risk protection assumed by the private market. The move to more aggressive and diverse risk syndication will thus be useful in helping policymakers think through which structures for assuming mortgage credit risk are most efficient and stable, which market participants are most likely to be interested, what the likely price of such capital might be, etc.
Of course, the mortgage insurance (MI) industry will be critical to any such expansion of risk-sharing, so the second step the agency is pursuing is to formalize stronger standards for the MI industry to ensure it can handle the load it will likely need to bear. The eligibility requirements for an MI to do business with the GSEs will be put out for notice and comment shortly, and the master policy agreements that set the terms by which the enterprises do business with the MIs have been largely finalized. With these standards in place, the MI industry will have to improve its practices and its fiscal health to play the increasingly important role likely needed of it.
Goal three: Building a better secondary market infrastructure
Under Director DeMarco, the enterprises were directed to form a joint venture to create a common securitization platform (CSP) to be used to securitize both agency securities and private label securities. The idea was to create something that could survive the GSEs and ultimately serve a market without government support.
Director Watt has narrowed the objective of this effort considerably, so that its initial focus will be more effectively creating securities issued within the current GSE system. The enterprises have also been directed to develop a single security to be issued through this platform. This move to a single security is intended to address the increasing liquidity challenge faced by Freddie Mac, which has fallen behind Ginnie Mae in its issuance of agency securities, requiring Freddie to provide a premium to investors in its securities. The two efforts together should increase the overall efficiency and stability of the securitization provided through the enterprises, improving liquidity in the market overall.
With this speech, Director Watt has formally ushered in a new era for the FHFA and GSEs. He has pivoted, rather emphatically, from the prior regime’s focus on preparing the enterprises for wind-down to better positioning them to serve as the central conduit for mortgage financing for the indefinite future. At a time when access to credit remains a serious challenge and the timing and shape of long term reform from Congress is deeply unclear, the pivot is a useful one. Even if one believes, as do I, that we need to chart a course for long-term reform, and that that course should involve the winding down of these two enterprises, that is arguably not the job of their conservator. The job of the FHFA is first and foremost to increase the stability and efficiency of the system as it stands. Director Watt has recognized this challenge and risen to it admirably.