Risky Business

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feature Solutions in Sync Bipartisan Policy Center intersects with FHFA's GSE scorecard on path to reform at just the right time. s e c on da r y m a r k e t a na ly t ic s se r v ic i ng Or ig i nat ion SECONDARY MARKET By Allen H. Jones J ust three weeks after the Bipartisan Policy Center's (BPC) Housing Commission released its report, "Housing America's Future: New Directions for National Policy," former HUD secretary and BPC co-chairman Mel Martinez elevated the discussion in testimony before the Senate Committee on Banking, Housing, and Urban Affairs. Former Sen. Martinez made the case for fixing a "broken" national housing finance system by reducing the government's exposure to credit risk, which will shift that responsibility largely to private credit enhancers. Coincidentally, at the same time Martinez was testifying, the U.S. House of Representatives Committee on Financial Services was holding a hearing on sustainable housing finance as an update from the Federal Housing Finance Agency (FHFA) on the GSE conservatorships. Acting FHFA Director Edward J. DeMarco was testifying on the status of the conservatorships and in particular the steps by which the GSEs would begin transferring credit risk to private capital. Both hearings took place on the morning of March 19. As the GSE conservatorships head toward their fifth anniversary, it appears the outline for headway in the GSE wind-down has commenced. Thematically, Martinez illustrated a transition to limiting the government role in housing to that of a "fourth loss position," and 76 | The M Report tactically, DeMarco spelled out the 2013 GSE scorecard that put teeth in the sale of credit risk positions for both Fannie Mae and Freddie Mac. The day DeMarco was questioned on next steps for the conservatorships and the fortuitous timing of the bipartisan center's report are not a mere coincidence. It appears the call for reform by the BPC and the action plan of the FHFA to move the debate forward represents a harbinger of real progress and the opportunity for resolution. The BPC's Consensus Approach A gainst a backdrop of a housing recovery, the time to augur the debate forward was right. With a fact-based approach and buoyed by what economists have seen in the stabilization of home prices, the BPC Housing Commission acknowledged the Fannie Mae and Freddie Mac operating models as we know them today should not be reproduced in the future. That is not to say that staff or existing capabilities of Fannie or Freddie could not be leveraged, just not in a business model that includes an implied government guarantee. Moving forward, the BPC Housing Commission espoused a "Public Guarantor" role that creates an explicit, but limited government backstop. While this provision rankles the taxpayers who have invested $187.5 billion in the GSEs through year-end 2012, it may provide the path forward to begin the retrenchment of the current government backing of 90 percent of mortgages outstanding in the United States. The BPC report speaks to the three layers of private capital that stand in front of the fourth loss position: the catastrophic credit risk position they suggest be borne by the federal government. Private Capital Ahead of Federal Backstop I n the first loss position in the BPC model is the mortgage borrower and his or her home equity. The second loss position is that of a private credit enhancer, ranging from capital market products to highly capitalized monoline mortgage insurers. The third loss position is the corporate resources of the securities' issuer, who maintains representation and warrant responsibility for the mortgage, and the servicer who is responsible for the timely payment of principal and interest. Then, in the BPC Housing Commission model, the government would step in as the fourth loss position. In theory, this model is similar to that of Ginnie Mae. In practice, the key will be attracting enough private capital to ensure the private credit enhancer has the wherewithal to meaningfully plug the second loss position. Significant Role of Private Credit Enhancers I n a mortgage market where the GSEs hold a $5 trillion position, the capital threshold for a qualified private credit enhancer is worthy of pause and consideration. The private credit enhancer must maintain sufficient capital to survive a housing decline like that we saw in 2006. Inasmuch as the private credit enhancer will bear the credit risk on guaranteed mortgage-backed securities—and be able to survive a housing decline of 30 to 35 percent, which corresponds to 4 to 5 percent on prime loans—the range of private capital needed is $100 billion, which is 2 percent of the $5 trillion outstanding.

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