Housing Finance Reform and Regulation of GSEs

Position

  • ICBA supports housing finance reform which is needed to preserve market liquidity, protect taxpayers, encourage the return of private capital, and ensure a stable national mortgage market for all stakeholders.
  • The Federal Housing Finance Agency (FHFA) must ensure that the GSEs operate in a safe sound manner. FHFA must follow the Housing and Economic Recovery Act of 2008 (HERA) and require both GSEs to develop and implement a capital restoration plan, start to retain earnings and, over time, build capital to a level that adequately supports their operations and protects U.S. taxpayers from future bailouts.
  • ICBA generally supports transfers of GSE credit risk through various risk sharing or loss sharing structures. However, ICBA urges the FHFA to actively manage this process to ensure these transactions: 1) are economically sound; 2) actually transfer a meaningful portion of credit risk to the private market; 3) provide benefits that are enjoyed by all GSE sellers and do not advantage any one GSE seller over others; and 4) do not impair the liquidity of the “to-be-announced” (TBA) market for GSE mortgage backed securities (MBS).
  • ICBA supports the use of deeper mortgage insurance provided the insurers are well capitalized, and are subject to the oversight and examination of FHFA.
  • FHFA should not divert GSE revenues to the Affordable Housing Trust Funds or other housing funds until both GSEs are adequately capitalized.
  • Any housing finance reform effort must provide robust and equitable secondary market access for lenders of all sizes, no competition at the retail level, and retention of mortgage servicing rights on transferred loans. The GSE secondary market structure must not be turned over to the largest national lenders and Wall Street institutions.
  • Many community banks rely on the FHLBanks’ mortgage programs for access to the secondary market, and this access point should be preserved.
  • Community banks must be able to sell loans on a single loan basis for cash, effectively hedge interest rates, and offer rate-locks at low cost.
  • Secondary market sales must be relatively simple. A process that requires complex credit enhancements, for example, will disadvantage community banks and other small lenders that lack the scale or resources to obtain and manage such enhancements from multiple parties.
  • Any successor to the GSEs must have a specific duty to serve all markets, including small towns and rural areas. Appraisal and underwriting guidelines must be flexible enough to accommodate the unique characteristics of these markets.
  • ICBA is committed to preserving the 30-year fixed-rate mortgage for creditworthy customers in all markets.
  • The recent financial crisis demonstrated that some type of government tie to the secondary market is needed to ensure the continued flow of credit. Any government catastrophic loss protection must be fully and explicitly priced into the guarantee fee and the loan-level price.
  • As stakeholders in the FDIC Deposit Insurance Fund, ICBA is concerned with proposals that would provide covered bond investors superior rights in receivership that are not provided to other secured creditors.

Background

Community banks represent approximately 20 percent of the mortgage market, and secondary market sales are a significant line of business for many community banks. According to a recent ICBA survey, nearly 70 percent of community bank respondents sell half or more of the mortgages they originate into the secondary market.1 While many community banks choose to hold most of their mortgage loans in portfolio, robust secondary market access remains critical for them to support mortgage lending demand. This is particularly true for fixed-rate lending. For a community bank, it is prohibitively expensive to hedge the interest rate risk that comes with fixed-rate lending. Secondary market sales eliminate this risk.

There is widespread agreement the secondary market must be reformed to prevent or greatly reduce the risk of devastating market failures that hobbled our economy. There is bipartisan consensus that, as the market recovers, the government’s dominant role in the housing market should be reduced to its more traditional role (less than 50 percent of secondary market sales). The private sector should return to its traditional role of providing the majority of the capital in mortgage finance. ICBA welcomes the return to a more balanced and less concentrated housing finance system with an appropriate role for portfolio lenders, originate-and-sell lenders, and small as well as large lenders. If implemented thoughtfully, such a system would reduce the moral hazard and taxpayer liability of the current system. Pending comprehensive reform, FHFA should require both GSEs to retain earnings and build capital in order to protect taxpayers from another bailout. Risk sharing or loss sharing transfers from the GSEs to the private market must not disrupt TBA market liquidity or contribute to further consolidation of the mortgage business. In particular, FHFA should not divert GSE revenues to the Affordable Housing Trust Funds or other housing funds until both GSEs are adequately capitalized.

The current GSE secondary mortgage market structure has worked well for community banks by providing equitable access, not competing at the retail level, and permitting community banks to retain mortgage servicing rights on the loans they sell.

Community banks selling directly to the GSEs today enjoy a very liquid market that permits them to effectively hedge interest rate risk and offer rate locks to their customers with relative ease and at a low cost. They access this market on a single loan basis, enjoy a virtually paperless loan delivery process, and generally receive funding from the GSEs in cash within 24 to 48 hours. Any new system of housing finance must be able to match the clear advantages of direct GSE sales enjoyed by community banks today.

Under the current GSE model, selling loans is relatively simple. Banks take out commitments to sell loans on a single-loan basis and are not required to obtain complex credit enhancements except for private mortgage insurance for loans in excess of 80 percent loan-to-value or other guarantees. Any future secondary market structure must preserve this relatively simple process for community banks and other small lenders that individually do not have the scale or resources to obtain and manage complex credit enhancements from multiple parties.

In creating a new housing finance system to address the problems of the old system and restore balance among portfolio lenders, small financial institutions, and large lenders, policymakers must be careful not to create a new system that eradicates liquidity for all but the largest players, limits access to the market or narrows options for smaller lenders, and imposes requirements that make it too costly for smaller lenders and servicers to participate.

1 ICBA Mortgage Lending Survey. September 2014.

Staff Contacts: Ron Haynie