As reported in a story published in StructuredFinanceNews.com yesterday, Federal Housing Finance Agency acting director Edward DeMarco reviewed the operating principles at work in the GSEs' conservatorship, highlighted some of the current initiatives and risks, and offered his thoughts on these agencies' future.  

DeMarco made the remarks in a speech at the American Mortgage Conference held yesterday.

The acting director, said Barclays Capital analysts in a report, was straightforward in his assessment of the GSE business model by calling it "broken beyond repair." He was also candid about the financial viability of these enterprises when he stated that these agencies will not be able to earn their way out of conservatorship given their losses.

The speech primarily looked at a private market solution  to replace the GSEs. DeMarco believes that “current pricing for credit guarantees is less than one would likely observe in a purely private, competitive market.” As such, he raised the possibility of gradually increasing the g-fees starting in 2012 to reflect competitive pricing.

"To put it bluntly, earlier incarnations of the g-fees badly missed the target," explained analysts at Bank of America Merrill Lynch in a report. "Even at their current levels, guarantee fees do not offset the average credit losses seen over the past several years."

DeMarco also proposed risk-based pricing across more product types and characteristics, limited geographic pricing, and the elimination of volume discount of g-fees to lenders. According to Barclays analysts, these changes are likely to increase costs for weaker credit borrowers, and potentially reduce differences across lenders and the two GSEs.

The FHFA acting director also highlighted the possibility of an increase in mortgage insurance, which could move the MI requirement threshold below the current 80% LTV. According to Barclays analysts, the move would generally reduce credit availability and leverage in the market. It would also require that MI providers take on additional credit and financial risk.

DeMarco reiterated his earlier position on Home Affordable Refinance Program or HARP, indicating a focus on high-LTV, performing borrowers already eligible for this government program.

"A solution that includes substantially higher guarantee fees would offset a large part of the resultant refi activity," said BofA Merrill analysts in the report. "If this turns out to be the next step in the refi.gov process, we would expect MBS to outperform, led by higher coupons."

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