February 4, 2010

Housing Committee
Federal Committee

This material is for discussion purposes only and has not been approved by the Housing Committee, Federal Committee or Board of Directors.

Issue: 
The Administration is expected to release their Government Sponsored Enterprise (GSE) reform recommendations as early as the end of January/ early February of 2010.  In response to this, NAR Leadership at their November business meetings in San Diego adopted policy recommendations from their GSE Presidential Advisory Group (PAG). 

Action:
Optional, C.A.R. Housing Committee leadership and Federal Committee leadership in December took the position that C.A.R. support NAR’s GSE policy and principles.  This action was taken so that C.A.R. may prepare to give input to Congress on this issue prior to the Administration’s recommendations and prepare for the February lobbying trip. 

Prior to this, C.A.R.’s GSE policy was limited to supporting a strong secondary market to maintain an affordable and stable flow of capital to the nation’s housing market.  C.A.R. had never addressed the issue of what structure the GSEs should take, and leadership and staff lacked sufficient policy direction to respond to Congressional inquiries.

Options:
1. Take no action, which would make the position taken by Committee leadership C.A.R. policy
2. Amend the position taken by Committee leadership

Status/Summary:
In September of 2008, the federal government fearing that the Government Sponsored Enterprises of Fannie Mae and Freddie Mac were on the verge of becoming insolvent placed them into conservatorship and named their regulator, the Federal Housing Finance Agency (FHFA) as their conservator.  Because Fannie and Freddie own or guarantee approximately 6 trillion dollars in mortgages and are financing approximately sixty-percent of the current housing market, their future is of the greatest importance to California REALTORS®.

Some of the questions Congress will be forced to address when discussing the future of Fannie and Freddie include:

• Can the GSEs continue in a quasi private/ public forms? 
• Should the GSEs be restructured in a manner that more closely resembles a public utility company?
• Should the GSEs be turned into completely private companies with no government support?
• Should the government permanently take over the GSEs?
• Does the market need both Fannie and Freddie? Or can they be combined?
• Are Fannie and Freddie salvageable? Or do they need to be eliminated and an entirely new entity created?
• What role should the government play in the future of the nation’s mortgage market? 
• What role should the GSEs play in promoting “affordable housing”?
• Is the current manner in which capital is brought to the mortgage market the most efficient way of doing it?  Should the U.S. look to drastically change how capital moves from investors to lenders by other financial instruments such as covered bonds? 

Different Proposals Considered by NAR:
A. Purely Private Secondary Market (no market-specific regulations)

 Pros:
• Desocialized risk
• Market discipline, preventing excessive risk taking/undue caution
• Product offerings shaped by market demand
Cons:
• Vulnerable to cyclicality, volatility, and credit crunches
• Lack of standardization and liquidity
• Consumer protection issues
• Even possible?

B. Public Function (Solely public secondary market)
 Pros:
• Government control over the level of risk
• Affordability/access due to high US government credit rating
• Fewer cyclicality problems due to “buyer of last resort” function
• Easy mortgage product standardization
 Cons:
• Socialized credit risk
• Politicized underwriting
• Little incentive for innovation
• Problems with agility—responsiveness to market challenges

C. Cooperative (Co-op of financial institutions guaranteeing MBS)
 Pros:
• Strong controls and limited risk taking because of participant risk
• Cost advantage over private-label MBS due to economies of scale
• Self-regulatory body, potentially leading to standardization, etc.
 Cons:
• Free-rider problem—individual members issue riskier loans
• Requires premiums and reserving
• Provides incomplete guarantee to investors
• Inability to temper cyclicality in housing finance
• Raises antitrust concerns

D. Risk Retention: Skin-in-the-Game Securitization (Require originators to retain interest in MBS)
 Pros:
• Already exists, to some degree
• Limits laundering to credit risk by mortgage originators
 Cons:
• Either incompatible with goals of mortgage securitization or requires the retention of large amounts of risk, limiting market size
o What is the proper amount of skin in the game? Any amount of skin in the game may be too much for some
• Risks recreating the asset-liability mismatch
• Lack of incentives for uniformity so without regulation, difficult for investors to evaluate potentially heterogeneous MBS

E. Risk Retention: Covered Bonds (Financing through secured bonds)
 Pros:
• Alleviates the incentive to sell “lemons” into the secondary market
• Better underwriting to the extent that the bonds are recourse
 Cons:
• Reliance on financial institutions to evaluate risk of mortgage pools
• Potential conflicts with deposit insurance
• Interest rate risk for depositories due to asset-liability mismatch
• Reduced lending capacity
• Without regulation, difficult for investors to evaluate potentially heterogeneous covered bonds

F. Federal MBS Insurance (Federal guarantee of timely payment of MBS coupons)
 Pros:
• Maintenance of countercyclical liquidity
• Insurance against erosion in underwriting standards
• Part of a potential insurance and underwriting regulation package
 Cons:
• Socialization of credit risk
• Requires (potentially politicized) premiums and reserving
• Inconsistent with risk-based pricing of mortgages
• Can the federal government engage in good insurance underwriting?

G. Public Utility (Privately owned monopoly regulated by government)
 Pros:
• Helps prevent excessive credit risk through profit regulation
• Monopoly status and profit regulation stop “race to the bottom”
• Countercyclical financing if utility has portfolio holdings
 Cons:
• Managerial rent-seeking—little incentive to control costs
• Politicization of profit regulation
• Risk of (political)geographic cross-subsidization
• Socialization of risks through implicit government guarantee
• Potential funding difficulties

NAR Position:
While NAR has now officially adopted policy recommendations, these recommendations were based on nine principles that guided both the GSE PAG and NAR staff.  This is important because even if Congress decides not to reform the GSE’s in a manner similar to NAR’s recommendations, the nine principles can still guide NAR on what criteria any recommended GSE reform must meet.

At the NAR 2009 November business meetings, NAR Leadership approved the following GSE PAG’s recommendations.

PROPOSED:
THE NATIONAL ASSOCIATION OF REALTORS® RECOMMENDATIONS
FOR RESTRUCTURING THE GOVERNMENT SPONSORED ENTERPRISES

Fannie Mae and Freddie Mac should be converted into government-chartered, non-profit corporations.  The corporations should ensure that the flow of capital continues to enter the mortgage market regardless of the state of the housing or mortgage markets or overall economy. 

The non-profit corporations should take the best components from the current GSEs, and import improvements from other secondary market models.  The current GSEs, Fannie Mae and Freddie Mac, are best positioned to become non-profit government corporations because of their existing infrastructure.  The transition from the existing GSEs to government non-profit corporations will be as smooth and seamless as possible, ensuring a continual flow of capital to the secondary market, which will be critical during any period of transition.

Unlike a federal agency, the new government non-profit corporations will function as self-sustaining organizations, without needing annual appropriations from Congress and without a profit motive.  NAR believes that any organization with a private profit and public loss structure, as the GSEs are presently structured, is inherently flawed.

Elements and Future Structure of the Proposed Government Non-Profit Corporation

The following elements should be incorporated in the new government non-profit corporations to ensure that the problems that caused the GSEs’ collapse do not arise again. 

1. The government must clearly, and explicitly, guarantee the business of this entity.  Taxpayer risk should be mitigated through the use of mortgage insurance on loan products with a loan to value ratio of 80 percent or higher and MBS guarantee fees.  Only if these two insurance pools prove to be insufficient in some future economic crisis would the federal taxpayer be called upon to make good on the MBSs.

2. The new entity’s mission must be consistent with NAR’s Principles for Ensuring a Strong, Robust Financing Environment for Homeownership and Multifamily Housing.

3. There must be strong oversight of the corporations by the Federal Housing Finance Agency (FHFA), including the providing of timely reports to allow for continual evaluation of its performance.

4. The governance structure should provide for a Chief Executive Officer to oversee daily operations, a Board of Directors with practical expertise to ensure effective and efficient operation, and an advisory board comprised of industry participants and consumer representatives to provide the organization, and its management, with real-time, front-line information regarding the corporation’s effectiveness and advice on the operation of the corporations.

5. Political independence of the corporations is mandatory for successful operation (i.e. the CEOs will have fixed terms so they cannot be fired without cause, and the corporations will be self funded – no ongoing appropriations). 

6. Sound and sensible underwriting standards must be established for loans purchased and securitized in MBSs, loans purchased for portfolio, and MBS purchases. 

7. The corporations will reinvest all excess revenue to accumulate capital in strong markets to pursue a countercyclical policy in weaker markets, and to support the secondary market, provide for innovation, remain mission focused, and maintain their capacity.

8. The organization must set standards for their MBSs that establish transparency and verifiability for loans within the MBSs that are purchased or securitized by the non-profit government corporations.

9. The primary purpose of the corporations’ portfolios will be to support their operations.  The portfolios should only be large enough to support their business needs and when necessary because of insufficient private investment, and only to the extent needed, ensure a stable supply of capital consistent with market conditions.

10. The corporations’ mission will focus on ensuring housing affordability for the under-served segment of the population, which includes ensuring housing affordability in multifamily rental housing.
 
11. The corporations should price loan products based on risk.  Housing affordability goals will assure that the corporations serve a full range of borrowers.
 
12. For commercial real estate, and as an additional way to provide more mortgage capital for residential housing, covered bonds should be explored as an option by both banks and the new corporations to encourage the piloting of niche initiatives (such as  the commercial green initiative) and to establish the tool’s viability.  An FDIC guarantee should be considered to enhance the covered bond option.

13. The corporations will be permanent (not expire).  
 
14. Two corporations are required to provide for competition in the secondary market and avoid the risk a single entity would lose incentive to innovate and to be efficient.
 
15. Reform of the credit rating agent is required, to address the inherent conflict of interest in the current system.

16. The corporations should only purchase and guarantee transparent and verifiable mortgage loans, and should only purchase derivatives as a last option in order to manage risk. 

As a guide, the GSE PAG utilized an NAR approved principles that are intended to direct NAR staff on issues dealing with the financing of property.  These principles are:

1. Ensure an active secondary mortgage market by facilitating the flow of capital into the mortgage market for all types of housing, in all market conditions.

2. Seek to ensure affordable mortgage rates for qualified borrowers.

3. Establish: (a) reasonable housing affordability goals so all qualified borrowers,  including low- and moderate-income households, have an opportunity to realize the dream of homeownership; and (b) reasonable multifamily rental housing affordability goals to increase the availability of financing for rental housing.  Housing affordability goals should not provide incentives for the institution that are inconsistent with sustainable homeownership or rental housing.

4. Require the institution to pass on the advantage of its lower borrowing costs (and other costs of raising capital) by making mortgages with lower rates and fees available to qualified borrowers.

5. Ensure mortgage availability throughout the nation. 

6. Require sound underwriting standards, consistent with NAR’s Responsible Lending Principles adopted in May 2005 (see attached).

7. Require the highest standards of transparency and soundness with respect to disclosure and structuring of mortgage related securities.

8. Ensure there is sufficient capital to support mortgage lending for all types of housing, in all market conditions. 

9. Provide for rigorous oversight.

C.A.R. Policy:
C.A.R.’s Housing Committee leadership and Federal Committee leadership took the position that C.A.R. adopt NAR’s GSE policy and principles as C.A.R. policy. 

While C.A.R. has taken policy positions in the past that would support a strong secondary market that is able to provide an affordable and stable flow of capital to the nation’s housing market, including policy that directly impacts Fannie and Freddie; C.A.R. has never been faced with the question of what structure the two GSEs should take.  In this aspect, C.A.R.’s does not have clear policy to either support or oppose any specific proposal, unless that proposal were to threaten the flow of capital to the housing market.

___________________
¹NAR's Reponsible Lending Policy supports requiring all mortgage originators to verify the borrower's ability to repay the loan based on all its terms, including taxes and insurance, without having to refinance or see the home (with limited exceptions for borrowers with significant assets).