FHFA Lays Groundwork for Private Secondary Market

Since Fannie Mae and Freddie Mac were thrown into conservatorship in September 2008, taxpayers have propped up the government-sponsored enterprises by providing more than $180 billion in capital — an amount that is unlikely to be fully repaid — according to a strategic plan for the pair of secondary lenders delivered Tuesday to Congress by their conservator, Federal Housing Finance Agency Acting Director Edward J. DeMarco.

The plan outlined three goals for the next phase of conservatorships: build a new secondary market infrastructure, gradually contract their domination of the mortgage markets and their operations, and maintain foreclosure prevention activity and credit availability for new loans.

“With the conservatorships operating for more than three years and no near-term resolution in sight, it is time to update and extend the goals and directions of the conservatorships,” DeMarco stated. “FHFA is contemplating next steps to build an infrastructure for the secondary mortgage market that is consistent with existing policy proposals and will support any outcome of the leading legislative proposals.”

The report, A Strategic Plan for Enterprise Conservatorships: The Next Chapter in a Story that Needs an Ending, indicated that the steps outlined in the plan are consistent with each housing finance reform framework outlined in last year’s white paper from the departments of the Treasury and Housing and Urban Development. In addition, the goals mesh with leading congressional proposals that have been introduced.

There is no infrastructure in existence that can support $100 billion in monthly mortgage securitizations that the housing finance agencies are currently guaranteeing, according to the plan. So shutting down Fannie and Freddie would push interest rates higher and reduce the availability of home-loan financing.

An infrastructure created without Fannie and Freddie would likely include a framework to connect borrowers to a securitization platform that bundles loans into any one of several security structures and provides administration for investors. The platform would have long-term value by permitting multiple future MBS issuers to access it and handling a wide array of securities and mortgage structures.

DeMarco suggested that the public utility structure might work well in the early stages of building a non-GSE infrastructure — though neither Fannie nor Freddie is capable of becoming a utility in their current forms — and such a development would require substantial taxpayer investment in human capital and information technology resources. If the GSEs did develop a single securitization platform, market participants would be given a lengthy transition period to avoid disruption.

A non-GSE infrastructure would also include a standardized pooling and servicing agreement that replaces the GSEs’ existing servicer participation agreement and fixes the shortcomings of pooling-and-servicing agreements previously used in the private-label mortgage-backed securities market.

In addition, transparent mortgage servicing requirements would be implemented that outline servicers’ responsibilities to investors and borrowers on issues such as servicing delinquent loans, soliciting borrowers for refinances or modifications, and servicing transfers. Servicer compensation would need to be structured to encourage competition, investors would need to receive current and detailed data about loans at issuance, and document custody and electronic registration would be needed.

FHFA is also recommending an open architecture would be needed to “facilitate entry to and exit from the marketplace and an ability to adapt to emerging technologies and legal requirements over time.”

In order to reach the plan’s second goal, reducing the operations of Fannie and Freddie, a path needs to be established to shift credit risk to private investors. Credit risk can be shifted by continuing to raise guarantee fees, establishing loss-sharing arrangements, and expanding reliance on mortgage insurance through deeper coverage.

While FHFA wants to wind down the GSEs’ combined $1.4 trillion investment portfolios, some of these assets will be held for a longer period to maximize returns — a key element of FHFA’s mandate as conservator — while market prices are depressed. One option for managing the investment portfolios includes retaining the capital markets staffing, though that would be disruptive and controversial given the executive compensation issue. The other option is to retain a third-party investment firm to manage the portfolios, though that could be more costly and pose new control and oversight challenges for FHFA.

The plan contrasted the GSEs’ multifamily businesses with their single-family businesses by highlighting how multifamily lending has generated a positive cash flow for both companies and how loan originators share credit risk through delegated underwriting or utilizing a class structure. In addition, Fannie and Freddie don’t dominate the multifamily market.

“Given these conditions, generating potential value for taxpayers and contracting the enterprises’ multifamily market footprint should be approached differently from single-family, and it may be accomplished using a much different and more direct method,” the report stated.

DeMarco said that the strategic plan benefits borrowers by continuing to stress foreclosure prevention and credit availability. Taxpayers will benefit by limiting losses from past activities, simplifying management and cutting exposure to future risk. Market participants will face less competition from the GSEs, and lawmakers will have a foundation from which to develop new legal frameworks and institutional arrangements.

The FHFA chief noted that public interest is best served by ensuring that Fannie and Freddie have the best available management in place to carry out the strategic plan — though FHFA has faced much resistance to offering enough compensation to attract top-caliber executives. The report indicated that the boards and executives who were responsible for the decisions that drove the GSEs into insolvency are “long gone,” while shareholder equity has been virtually wiped out.

“The early chapters of the conservatorship story focused on market functioning and loss mitigation,” the plan stated. “More recent chapters have covered renewed efforts to enhance refinancing opportunities and real estate owned disposition.

“The strategic goals and performance objectives set forth here provide an outline for the next chapter of the story, one that focuses in earnest on building a secondary mortgage market infrastructure that will live beyond the enterprises.”