Testimony from four government agencies regarding a proposed government-sponsored enterprise regulation overhaul has sent the mortgage market into a tailspin, with the Fannie Mae 10-year benchmark widening to its highest level ever recorded.
While much of the hoopla in the market was in reference to the testimony of Gary Gensler, undersecretary of the Department of Treasury for domestic markets, the testimonies of three other prominent players in the market generally went overlooked.
The bill, sponsored by Rep. Richard Baker (R., La), chair of the House subcommittee on capital markets, securities and GSEs, was introduced Feb. 29. The testimony given last Wednesday was the first major hearing on the legislation, known as HR 3703, the Housing Finance Regulatory Improvement Act.
Its aim is to combine the safety and soundness and mission regulators of Fannie Mae, Freddie Mac and the Federal Home Loan Bank System into one agency. Ultimately, the new agency, the Federal Housing Oversight Board (FHOB), will stop the GSEs from pursuing activities outside their congressionally chartered missions and reduce systemic risk, further distancing the GSEs from the federal government.
What Set the Market Off?
Among the most prominent features of the legislation is that, if passed, it would repeal the lines of credit the GSEs have with the Treasury - currently $2.5 billion for Fannie Mae and Freddie Mac, and $4 billion for the FHLBanks. Gensler cited that such a repeal would be a symbolic measure, to reiterate that GSE securities do not have a government guarantee.
"The dollar amounts of these lines are now a mere fraction of the GSE's annual borrowings," Gensler said, noting that total guarantees of Fannie Mae and Freddie Mac are $1.4 trillion - about the size of the entire municipal bond market.
One source closely following the legislation said, "And he was right. It is largely symbolic. They issue so much debt now - up in the trillions - what the hell is two and a half billion in credit?"
However, Bruce Morrison, chairman of the Federal Housing Finance Board, the regulator for the FHLBanks, believes that cutting that credit line would send a wrong message to investors of GSE debt. "The line of credit exists and it contributes to the lower funding costs supplied by capital market pricing of FHLBank System consolidated obligations," he said. "Removal of the line of credit could adversely affect these costs with no reciprocal reduction in government exposure."
Gensler also said that the requirement that banks cannot hold more than 10% of a particular institution's securities in their portfolios does not apply to GSE securities. "We believe that Congress should seriously consider the best way to repeal such exceptions, including a sufficient transition period to prevent any market disruption," he said.
Greg Rosenberg, a mortgage-backed securities researcher at J.P. Morgan, said that this aspect of the bill would have more of an impact on the market than the implicit guarantee. "If they were going to regulate that to subject banks - having no more than 10% of their assets with the GSEs or something - that might actually have a big impact in terms of what people would have to do to correct that situation," he said, adding that some banks have large concentrations in GSE debt or GSE passthroughs in their portfolios.
"The market has reacted with hysteria," said Art Frank, head of MBS research at Nomura Securities. The Fannie Mae 10-year spreads had widened six basis points shortly after the testimonies last week, and went out to 112 over Treasurys briefly Thursday morning - the widest spreads ever seen for that issue - tightening back in to 103 within 10 minutes.
Rosenberg added that Ginnie Mae securities outperformed conventionals in light of the testimony. "I think that's a response to ... jitteriness over conventionals, given this kind of changing perceptions over how great the implicit guarantee is."
By market's close Thursday afternoon, the mortgages had recovered, in response to the variety of constituencies that spoke on the issue. "In retrospect, the market did over-react last night and this morning, and a lot of US investors saw that and came in to buy," Frank said.
Left Out of the Fanfare
"The problem is, everybody quoted Gensler," Frank said, referring to the fact that four people gave testimony Wednesday. Gensler was more supportive of the legislation than William Apgar, assistant secretary for housing under the Department of Housing and Urban Development (HUD), indicating that the Clinton Administration is not ready to take an official stance on the bill, either way.
Both Apgar, and Armando Falcon, the director for the Office of Federal Housing Enterprise Oversight (OFHEO) - the safety and soundness regulators for Fannie Mae and Freddie Mac - said that while there is always room for improvement, the current setup is working just fine.
"Consolidation of the safety and soundness regulation of the housing GSEs could lead to even stronger oversight, if done right," Falcon said. "However, the consolidation of mission regulation with safety and soundness regulation is not essential for OFHEO or its successor to properly fulfill its safety and soundness responsibility."
"We recognize that for the long haul, revisions to the existing regulatory structure may be necessary to keep pace with the changing market conditions," added Apgar.
Some of the most agreed-upon sections of HR 3703 were those to increase transparency in the market, and to establish annual credit ratings of the GSEs.
One clause allows the FHOB to make information public that it determines would increase the efficiency of the secondary mortgage market or the housing finance system. However, Gensler said that it should be noted that some information should be considered proprietary and not be made available to the public.
"Fannie Mae and Freddie Mac should be subject to a higher standard when it comes to the release of such information," Apgar added, also hinting concern toward releasing proprietary information. He said that doing so could have a negative impact on their business operations and their financial condition.
As for the annual credit rating, Falcon said, "With adequate funding, regular updates of this type would provide more information to investors about the enterprises' financial condition and would provide an additional source of information about the enterprises' financial condition to the regulator."
Will It Get Passed?
Congressman Baker has hinted that it is unlikely that HR 3703 would move very far in 2000. Nomura's Frank indicated that it is very unlikely to be passed at all in its current form, and that, "It's one of a number of mortgage-market issues that's going to be addressed in a new administration, with a new congress in 2001."