Will GSE reform get some clarity from long-awaited blueprints?

WASHINGTON — The mortgage industry will be looking for answers when the Trump administration unveils its plans to shake up the housing finance system and end the conservatorships of Fannie Mae and Freddie Mac. But the blueprints could raise just as many questions.

A path forward for the government-sponsored enterprises has essentially been 11 years in the making, with the mortgage giants sitting in limbo under federal control for the past decade.

Many hope that the upcoming, presidentially directed reports by the Treasury Department and the Department of Housing and Urban Development will provide some clarity.

The blueprints are expected to be released after Labor Day. Key issues will be whether the reports offer guidance on how much capital Fannie and Freddie should hold, the status of a government guarantee and the involvement of Congress in developing a reform plan.

In its March memo, the Trump administration said it was looking for solutions that would promote competition in the mortgage market, create sustainable homeownership options and protect taxpayers from future bailouts. Sustainable homeownership is the “benchmark of success” for reform, according to a White House press release issued at the time.

In what could be the most significant step to date toward ending government control of Fannie and Freddie, Federal Housing Finance Agency Director Mark Calabria and Treasury Secretary Steven Mnuchin may discuss changes to the "net worth sweep," a series of agreements governing how the mortgage giants transfer revenue to the government. But Calabria has said he is waiting to review the upcoming reports on GSE reform before addressing changes to those agreements.

Still, some industry stakeholders and consumer groups suggest the reports could offer just broad strokes, leaving the real reform work for later.

“I just don’t know how aggressive the Trump administration wants to be, and so I think that’s going to be an indication to see if they’re looking to maintain the status quo or if they really are trying to change the dynamic,” said Ted Tozer, a senior fellow at the Milken Institute and former president of Ginnie Mae.

Experts have pointed to four areas in particular to look out for when the reports are released that should provide valuable insight into the administration’s direction on housing finance reform.

Strengthening Fannie and Freddie's capital
FHFA Director Mark Calabria
Calabria has said one of his main goals during his five-year tenure as the regulator of Fannie and Freddie is to ensure that the GSEs have adequate capital levels.

“As a regulator, my primary concern is that the GSEs maintain capital levels commensurate with their risk profiles,” he said in a speech in May. “And over time I think Fannie and Freddie ought to operate under essentially the same capital rules as other large financial institutions.”

The Treasury report could provide the first indication of the administration’s plan for recapitalization, as well as how officials intend to restructure the net worth sweep agreements, said Andrew Jakabovics, the vice president of policy development at Enterprise Community Partners.

In 2012, the FHFA and Treasury altered the senior preferred stock purchase agreements to require Fannie and Freddie to deliver nearly all of their profits to the Treasury Department in an effort to repay taxpayers, leaving the GSEs with an incredibly small capital cushion of $3 billion each.

“That’ll be interesting to see how much do they strike the profit sweep entirely,” said Jakabovics. “Do they restructure it so that there’s still some money flowing into the Treasury from the entities, but otherwise allow them to recapitalize at a slower or faster rate?”

While some industry observers have mused that the Trump administration wouldn’t be likely to make any major changes to the housing finance system in the lead-up to the 2020 election for fear of disrupting the economy, ending the net worth sweep doesn’t pose a risk to financial stability, said Tozer.

“I could see the policy saying that immediately they’re going to have Fannie and Freddie start retaining their income, and stop the sweep so they can build capital,” he said. “That’s not going to effect the economy, except it is going to exacerbate the national debt because that money is going to have to be replaced by Treasury debt. But I could see the administration taking the tactic of, well, that’s really no big deal.”

Still, Calabria might be more likely than Treasury to take the lead on capital. The FHFA is reviewing a proposal under Calabria’s predecessor, Mel Watt, to implement a risk-based capital framework that would take effect once the GSEs exit conservatorship.

“I don’t expect the Treasury or HUD papers to shine much light on that,” said Robert Broeksmit, the president and CEO of the Mortgage Bankers Association. “I think that’s more in Director Calabria’s gambit, and we hear or expect that that probably would be finalized maybe in January or so.”

Calabria told American Banker in June that he did not foresee the agency reissuing the proposal, but if it did the new proposal would push the effective date back by several months.
The timeline for reform
FHFA headquarters in Washington, D.C.
Calabria has said that changes to the preferred stock purchase agreements would accompany a plan for Fannie and Freddie to exit conservatorship, but that those changes may not coincide with a specific end date in mind for the conservatorship. Rather, the trigger could be hitting certain goals on a checklist of progress toward releasing the companies from government control.

It’s unlikely that Treasury would tack specific dates onto a plan as well, said Broeksmit.

“I would be surprised if the paper gave any specificity on a timeline,” he said. “I think there’s an understanding that this process is complex and fluid and there is a sincere desire by the administration not to act in a precipitous way that might cause harm to a housing market that, despite very low interest rates, remains a little sluggish on both the home building and home purchasing side.”

But the report could provide a sense of the next steps the Trump administration might take to loosen the government’s grasp on Fannie and Freddie, especially its plans for working in tandem with Congress.

“There is broad consensus that the guarantee should be paid for to eliminate and sort of privatize losses, but that’s going to require congressional activity,” said Jakabovics. “So how much of the administrative steps come before, [or] do they come after any potential legislative activity?”

Yet Treasury and HUD are likely aware that relying on Congress to take the lead in the next 18 months is a non-starter.

“The authors understand that in a divided Congress, and especially as 2020 gets closer, passing large-scale legislation is a very difficult lift,” said Broeksmit.

That could increase the likelihood of a broader report from Treasury and HUD instead of one that dives deep into the details of reform, added Jakabovics.

“Moving into an election year, obviously the window for massive structural change is closing pretty quickly, so I don’t know how that plays into either what they want to see and whether this document is really ultimately going to be a very detailed step-by-step [plan], or whether it is more of an aspirational guidance document back to FHFA,” he said.
A role for Congress
Rep. Patrick McHenry, R-N.C., the top Republican on the House Financial Services Committee with Chairman Maxine Waters, D-Calif.
The presidential directive that President Trump signed in March asked for both administrative and legislative solutions to modernize the nation’s housing finance system.

While the chance that Congress takes up housing finance reform legislation remains slim, some of the elements of reform that the administration officials have advocated for — such as an explicit government guarantee — can only be accomplished through legislation.

“When it comes to Fannie and Freddie, I’m curious to find out just how much the administration really looks at how important the government guarantee is,” said Tozer. “Congress can only give an explicit guarantee, so the question is, will the paper acknowledge that, or will it try and say again that if you have enough capital, nobody is going to care?”

Some have argued that ample capital for the two GSEs could serve as a substitute for an explicit guarantee in the eyes of investors.

For Jakabovics, “it’ll be interesting to see the executive branch’s view of how much they both can and want to do within their existing authorities, and how much they’re going to put the onus on Congress.”

The Trump administration might even use the report to convince Congress to finally move toward accomplishing real reform, said Broeksmit.

“I believe they would use the report as a way to spur congressional action in terms of creating that explicit, paid-for guarantee behind private capital for the GSEs’ mortgage-backed securities and also a method for chartering new entrants,” he said.

But at the same time, administration officials won’t wait for Congress to act, and instead will use the report to outline what they can do independent of legislation, Broeksmit said.

The idea of Congress rallying around a few major components of reform isn’t outside of the realm of possibility, said Jakabovics.

“Obviously the devil is always going to be in the details on some of this, but I don’t think that moving toward a paid-for guarantee and standing up some entity to backstop it is out of the range of possibility to reach bipartisan consensus,” he said.

Congress would also be much more likely to take up the role of affordable housing in GSE reform than the administration, said David Dworkin, the president and CEO of the National Housing Conference.

“Because so much of the affordable housing requirements are set in law, Congress is the only place you can make dramatic change and still be compliant with the law,” he said.
How GSE reform will affect the Federal Housing Administration
Department of Housing and Urban Development
While Treasury’s half of the report on housing finance reform will garner much of the industry’s attention, HUD’s report on its role — and particularly that of the Federal Housing Administration — in bolstering sustainable homeownership will be important to watch, stakeholders say.

“The administration has been intentional about changing this debate from GSE reform to housing finance reform,” said Broeksmit. “I think the administration has rightly realized that one could make some changes to the GSEs that would have spillover effects on FHA that may not be desirable.”

For example, if the report were to suggest cutting down on the risky loans that Fannie and Freddie back, it could push more volume to the FHA, which would undercut the administration’s aim of protecting taxpayers.

“A lot of the focus is going to be on the operational capacity on FHA … and I think at Ginnie [Mae] as well,” said Jakabovics. “It will be interesting how they envision the interplay between the GSEs and FHA in terms of market coverage.”

The report could also provide an opportunity for the administration to state its view on the increasingly popular legislative idea that Ginnie Mae serve as the backstop for Fannie and Freddie, said Tozer.

“Pretty much all the Senate and all the House bills that came out all had Ginnie Mae being the guarantor of all the [mortgage-backed securities] that were coming out, so it will be interesting if they pick up on that,” he said. “I’m kind of curious myself to see what they do with that, or if they just keep it confined to the FHA and VA space.”