The foundations of housing reform

ICBA’s new white paper makes the community bank case for reforming Fannie and Freddie.

By Ron Haynie

Housing-finance reform has been the enigma of Washington’s response to the financial crisis. Following their September 2008 conservatorship by the Federal Housing Finance Agency and Treasury Department, the question of what to do with government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac has vexed policymakers, who have repeatedly delayed fundamental reforms or resolution.

Just about the only thing that is agreed upon is that reform is needed for a system now dominated by the federal government and vulnerable to future market failures. Fannie and Freddie have returned to profitability, worked through most of their defaulted loans, and continued to provide housing-market liquidity under conservatorship. But they are bleeding out earnings and capital in their quarterly dividends to the U.S. Treasury, having paid out nearly $80 billion more than they received in relief during the crisis. Without any change to their agreement with Treasury, the capital buffers of both GSEs will drop to zero by Jan. 1, 2018.

To move the discussion forward and support continued access to the secondary mortgage market for community banks, ICBA recently released a white paper with its principles and recommendations for housing-finance reform. The white paper calls on policymakers to allow Fannie and Freddie to rebuild their capital buffers while preserving equal access to the secondary market for lenders of all sizes.

Principles for reform
Community banks represent approximately 20 percent of the mortgage market, and secondary market sales are a significant line of business for many. According to a 2014 ICBA survey, nearly 70 percent of community bank respondents sell into the secondary market half or more of the mortgages they originate. ICBA welcomes the return to a more balanced and less concentrated housing-finance system, but robust community bank access to the secondary market will remain critical to continue supporting the demand for mortgage lending.

Community banks depend on Fannie and Freddie to provide them with secondary market access without having to sell their loans through a larger competitor. The GSEs provide a liquid market that allows community bank lenders to effectively hedge interest rate risk and offer rate locks to their customers with relative ease and at a low cost. Any future secondary market structure must preserve this relatively simple process for community banks, which do not have the scale or resources to obtain and manage complex mortgage pipeline hedging programs and credit enhancements from multiple parties.

With that in mind, ICBA’s GSE white paper lays out its core principles for reform:

  • Allowing Fannie and Freddie to rebuild their capital buffers to prevent market disruption caused by a draw by one or both GSEs from the US Treasury.
  • Providing competitive, equal and direct access to the market on a single-loan basis and the continued ability to retain local servicing of those loans.
  • Allowing the GSEs to be adequately capitalized, liquid and reliable enough to effectively serve the entire mortgage industry.
  • Reducing the risks posed to the GSEs by credit-risk transfers, which drain their revenues and expose them to operational risks.
  • Ensuring an explicit, paid-for government guarantee of GSE mortgage-backed securities and strong oversight from a single regulator.
  • Preserving the to-be-announced market, which allows lenders to offer interest-rate locks while hedging risk.
  • Maintaining simplicity and barring GSE asset sell-offs to the private market.
  • Addressing the claims of GSE shareholders.

The way forward
To carry out these principles, ICBA’s white paper also outlines a way to move forward with needed administrative and legislative reforms. Much authority already exists for the Federal Housing Finance Agency to carry out key ICBA proposals under the Housing and Economic Recovery Act of 2008 (HERA). These include ending the GSEs’ net-worth sweep, establishing capital-restoration plans and delaying the launch of its Uniform Mortgage Backed Security until the GSEs are recapitalized and released from conservatorship.

ICBA’s plan does require congressional action, however, including our call for a catastrophic mortgage insurance fund to be administered by the FHFA and funded through GSE guaranty fees. The size of the fund would be determined based on actuarial standards and would be similar to the FDIC’s Deposit Insurance Fund to stand behind the explicit US government guarantee of GSE mortgage-backed securities.

Additionally, ICBA’s plan calls for changing the GSEs to regulated and shareholder-owned financial utilities, which would allow shareholders to exchange their shares and require Treasury to divest itself from its shares once the company is well capitalized.

GSE reform will be complex and difficult, but it remains critically important to the future of the housing market and the US economy. While HERA provides the road map needed to restore the GSEs to a safe and sound condition, Congress will need to act. Nevertheless, ICBA’s approach to reform is as simple as possible: using what already works well and addressing the parts that do not.

Ultimately, a strong plan to improve the GSEs’ capital position, grow earnings, manage expenses and restore high-quality service and increased liquidity will drive a more robust primary and secondary mortgage market. It will make the housing finance system safer and more sound, providing access to lenders of all sizes and the communities they serve.

Ron Haynie ( is ICBA senior vice president of mortgage finance policy.