At the Securities Industry and Financial Markets Association’s (SIFMA) panel on GSE reform held yesterday, participants discussed the future role of Fannie Mae and Freddie Mac in light of the upcoming debate in Congress.
The discussion on GSE reform was held at SIFMA’s New York headquarters with the following participants: Jay Diamond, managing director at Annaly Capital Management; Bert Ely, CEO of Ely & Co.; Mahesh Swaminathan, head of RMBS strategy at Credit Suisse; and Ann Schnare, president of AB Schnare & Associates.
Chris Killian, SIFMA vice president and panel moderator, said that GSE reform has been a topic of major importance since the end of last year. In this light, SIFMA established a working group on GSE reform.
Killian stressed the importance of a thoughtful transition regardless of what the new policies will eventually entail.
“As much as there is great criticism, positive aspects have grown out of the current U.S. system,” he said, citing the advent of the 30- year fixed-rate mortgage as one of the housing market’s most substantial accomplishments.
In his comments, Ely voiced his concerns over the significant growth of home mortgage debt relative to GDP and the U.S.’s position as the world’s biggest debtor. He denounced the nationalization of mortgage credit and called for a re-privatization of mortgage credit risk.
Meanwhile, Diamond noted that home equity in the U.S. actually declined at the turn of the millennium while home prices were climbing at record rates. He then blamed affordability products made before the crisis, which were poorly underwritten and many of which were “made to fail.”
Despite the problems faced by the mortgage industry in the past few years, Diamond called the U.S. housing market the most efficient in the world and didn’t accept total privatization of GSEs as a beneficial option .
He described the GSEs as the portals “through which the borrower meets the secondary market.” He added that these agencies allow smaller lenders to compete with larger ones.
He emphasized the importance of Freddie Mac’s and Fannie Mae’s role as guarantors. “Financing is available and priced where it is because of the wrap,” he said.
Swaminathan said that he doubted that a totally private system, where a firm’s incentives might not be aligned with public interest, would be able to maintain investor confidence in times of crisis. The GSE model, he said, is more sustainable than using the Federal Reserve’s balance sheet long-term because the agencies have the necessary expertise and infrastructure.
He suggested that GSE reform should seek to avoid excessive leverage by employing graduated capital standards and should return to the strict underwriting standards used during the 1990s. He called for higher capital standards and counter-cyclical capital requirements to ensure the agencies’ ability to operate even after a catastrophic credit loss.
Schnare highlighted the stark polarization between two very different camps when it comes to GSE reform. Conservatives, she said, are not concerned with the 30-year mortgage and fundamentally disagree with the mission of supporting homeownership in general. This camp, therefore, cannot be swayed by the arguments of progressive agency supporters.
She explained the different perspectives on the proposal for a single security, which would allow for competition with Fannie and Freddie but might lead to the vertical integration by large financial institutions.
Progressive groups with ties to the Obama administration are supporting a plan that would include an insurance pool to absorb taxpayer losses in times of distress, she added.
The public, she said, tend to agree on the need for explicit guarantees, private conduits, and the protection of taxpayer dollars, stronger regulation, and higher capital standards.
Schnare also commented on the intensely political nature of the proposed GSE reform. “There is no room for compromise,” she said. “If Republicans take the midterm elections, there could be stalemate on the issue.”
Ely agreed that November would prove crucial to the ultimate fate of GSE reform, as the diametrically opposed positions of policymakers could delay a vote if the Democratic majority in either house of Congress is not maintained.
Covered Bonds
The panel also focused on the possibility of covered bonds providing an alternative to the GSEs.
Ely, who referred to himself as the “champion of covered bonds,” said that the sector is a means to achieve safer and more efficient markets in place of direct federal government involvement.
He noted the higher credit rating and lower funding costs associated with covered bonds, although said that GSE reform legislation should be kept separate from any attempt to promote covered bonds in the immediate future.
Meanwhile, Diamond agreed that covered bonds could be an interesting part of potential reform, but was skeptical about the prospect of a replacement for securitizations in the U.S.
Schnare said that covered bonds are not particularly well suited for funding 30-year fixed-rate mortgages and would likely pose certain limitations to potential homebuyers.
Swaminathan highlighted the problems that covered bonds have posed in European markets. The sector, he said, froze during the credit crisis in a manner similar to other mortgage financing instruments.
