March 2016 - RIP Dodd Frank

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24 | TH E M R EP O RT FEATURE T hough many experts have said housing finance reform is unlikely this year, the time is now to explore the fundamentals of how that reform could happen. Uni- form and transparent measures of credit risks will play a key role—whether it's in 2016, 2017, or beyond. The State of Risk Measurement M ost people involved in the mortgage industry don't think about weights and measures, but ensuring these uniform standards is essential for commerce, and it's a core func - tion of government. Although the government has established weights and measures in some areas of housing finance—for example, APR—it unfortunately has not done so in the important area of credit risk. The term "credit risk" means different things to different policymak - ers, and it differs in the context of housing finance programs, too. This continuing lack of a uniform and clearly articulated definition of credit risk has pro- duced unintended consequences, and it stalls prospects for hous- ing finance reform. A little background: The mortgage insurance (MI) industry provides credit default protection on residential mortgages and intersects with federal housing policy in two important ways. The first point of intersection is with Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSEs), and occurs because the majority of insurance written by the MI industry since 2008 has been for loans purchased by the GSEs. MI is commonly used to satisfy the credit enhancement requirement for low down-payment (generally less than 20 percent) mortgages found in the GSEs' corporate charters. In 2008, the federal government took control of the GSEs through a conservatorship process. The Federal Housing Finance Agency (FHFA) is now the conservator of the GSEs and has the authority to control and direct their operations. Although bank portfolio lending has revived a bit since 2008, private label securitization of mortgages remains stagnant. Because of this, GSE-purchased mortgages— or conventional conforming mortgages—constitute the main outlet for fixed-rate mortgage originations by lenders and the main source of insurance business for the MI industry. As such, any action taken by the GSEs or the FHFA—or any housing finance policy that affects the GSEs, for that matter—will have notable influence on the MI industry. The second point of intersec - tion is with the Federal Housing Administration (FHA) and its Mutual Mortgage Insurance Fund. The FHA has coexisted with the MI industry since the mid-1950s, and they overlap in significant respects. The FHA and the MI industry each seek to serve the en - tire prime mortgage market where mortgage insurance is needed, including the sub-markets related to first-time homebuyers and low down-payment borrowers. Unlike homeowners insurance and auto insurance, where government fa - cilities generally provide insurance only for those unable to obtain private insurance, the government facility provided by the FHA in- sures loans the private MI industry is able to and seeks to insure. The Great Recession compli- cated matters even further. When the GSEs were put into conser- vatorship, the implicit guarantee supporting the GSEs was made explicit, with the U.S. Treasury as the backstop credit guaran- tor. At the same time, the FHA enjoys permanent and indefinite authority to draw on the U.S. Treasury for funds if needed—and it did in 2013. So, despite a market distinction between conventional conforming mortgages and govern- ment mortgages, the GSEs and the FHA actually share the same backstop credit guarantor—the U.S. Treasury itself. Additionally, the dire circum - stances of the housing crisis in 2008 and 2009 forced dramatic actions, notwithstanding the Treasury guarantee. The GSEs increased their guarantee fees and loan-level price adjustments (LLPAs), imposed adverse market delivery charges, and generally tightened credit underwriting stan - dards to stabilize operations. The MI industry also adjusted pricing and terms for similar reasons. As a result, capacity for new conven - tional conforming mortgages was dramatically curtailed, and pricing for such mortgages was materi- ally increased. Because the FHA did not immediately adjust pricing or terms, government mortgages became more available and cheaper for many borrowers than conven - tional conforming mortgages—at least based on monthly payments. The resulting consequence of all these changes was a dramatic increase in the FHA's volume and subsequent U.S. Treasury support. The Current Problem I n 2009 and 2010, the US Treasury and HUD studied the housing finance market and issued their white paper titled "Reforming America's Housing Finance Market" in February Expect Delays Disjointed Risk Measurement Stalls Finance Reform Before It Starts. Is It Time the Industry Found an Alternate Route? By Patrick Sinks

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