GSE Reform in 2018
GSE reform has been gaining momentum in 2018, but final passage by Congress is getting tougher. Government-sponsored entities (GSE), like Fannie Mae and Freddie Mac, were largely blamed for contributing to the real estate bubble and subsequent mortgage crisis. As a result, both agencies were placed in conservatorship for nearly a decade. Since February 2018, over 160 mortgage banking lenders from 42 states signed off on an open letter urging Congress to accelerate efforts to pass GSE reform.
Lessons from the Housing Bubble
Prior to the bailout, Fannie Mae and Freddie Mac were virtual monopolies in the secondary mortgage markets. They had exclusive cheaper borrowing and lending rates supported by implicit government backing. This is when Wall Street created riskier financial products to compete in a "race to the bottom" that ultimately led to the financial meltdown of 2008. Pundits have pushed for legislation that would level the playing field among all participants and bolster free market competition. Taking lessons from the housing bubble, the common principles of reform were established.
Three Common Principles of GSE Reform
Backed by the Mortgage Bankers Association (MBA), the open letter outlines three core principles on comprehensive secondary mortgage market reform:
- Maintain the explicit federal guarantee on mortgage securities for multifamily rentals. This would preserve the 30-year fixed-rate loan and stabilize confidence.
- Enable significantly more private capital at risk ahead of taxpayers
- Implement a utility-like regulatory framework enabling equal access and terms to secondary markets for all lenders and business models. This would bolster competition while regulating returns to contain risk, maintain stability and encourage patient capital investment with a long-term horizon.
A Guarantor-Based System
Based on these principles, the MBA supports a "reformed" guarantor model. The new model requires less plumbing by improving the existing system by chartering more guarantors to compete with Fannie Mae and Freddie Mac in the secondary market. Guarantors would seek to acquire and securitize mortgages, just like the GSEs, providing the same price and credit terms for all lenders regardless of their size or business model. Additionally, guarantors can't be owned, affiliated or be a subsidiary of any single lender, bank, firm or institution. And no single institution can own more than 5 percent of the stock of a guarantor. This maintains the separation between the primary and secondary mortgage markets.
The Leaked Corker-Warner Bill
A leaked Senate bill sponsored by Senators Bob Corker-TN and Mark Warner-VA, the Corker-Warner draft, embodies the spirit of the reformed guarantor model by ultimately replacing Fannie Mae and Freddie Mac with private guarantors that compete on a level playing field in the acquisition and securitization of mortgages. The private guarantors would issue mortgage-backed securities (MBS) and have sufficient capital reserves to absorb losses before triggering the explicit government guarantee in catastrophic scenarios. Neither senator has released the final bill as of March 2018.
The State of Reform
The economic recovery since the market crash and absence of crisis have induced Congress to embrace the "status quo." The MBA procured a white paper outlining the transition from status quo to end state, but they need Congress to secure legislation ahead of the upcoming November midterm elections for any shot at GSE reform this year. Failing to pass Congressional legislation would enable the executive branch to move forward with changes to the mortgage market via the Federal Housing Finance Agency (FHFA) and the Treasury Department without Congressional input.
As the midterm elections approach, the focus will shift to higher priority "election" issues that garner votes. The planned retirement of two key drivers for reform — Senator Corker and House Financial Services Committee Chairman Jeb Hensarling, R-Texas — complicates matters. Democrats wanting to win back the House of Representatives may have even less incentive to engage in negotiations ahead of November. Unfortunately, GSE reform is not an election issue.
To discuss in more detail, contact your mortgage banker, or Janette O’Brien at Janette_OBrien@KeyBank.com.