Counsel and industry are pushing to boost private label securities (PLS) as the reform of government sponsored enterprises (GSEs) rises up the regulatory agenda. But uncertainty surrounds the best manner in which to do it.
Freddie Mac and Fannie Mae play critical roles in the US market for residential mortgage backed securities (RMBS). But their presence in the RMBS market suppresses the private mortgage market.
“Right now, PLS can’t compete with Federal Housing Administration (FHA) loans or the GSEs,” said Christopher Killian, managing director at Securities Industry and Financial Markets Association (Sifma).
For Killian, however, GSE reform is not something to be rushed. “What do you do to get private label securities going, when that side of the market is smaller than it should be?,” he said.
“Do you pull back on government involvement in order to stimulate the private label side, or do you stimulate the private side before you can pull back on government involvement?,” said Killian.
The scale of government involvement in the US mortgage market is huge. According to the Federal Housing Finance Agency (FHFA), Fannie and Freddie together provide more than $5.5 trillion in funding for the US mortgage markets. That money goes to buying mortgage loans from banks. Cutting off that liquidity too quickly would be problematic.
“You don’t want to pull back the government too soon, as there’s a very high proportion of mortgage origination going through the government,” said Killian.
Avenues to reform
There is still strong appetite for GSE reform. In 2015, US Senator Richard Shelby introduced the Financial Regulatory Improvement Act. The Act included suggested GSE reforms aimed at boosting private capital in the US mortgage market, although the Act isn’t likely to become law.
It’s not just legislation that could spur changes. In theory, Fannie and Freddie could do it themselves, according to Lewis Cohen, partner at Hogan Lovells.
According to Cohen, two actions could stimulate the PLS market. Both are within the power of GSEs. One would be to lower the cap above which Fannie and Freddie can't purchase loans. The other would be to raise the guarantee fee, which would make it less economic to go through GSEs. But neither GSE is incentivised to make such changes.
“Neither are going anywhere,” said Cohen.
There have been attempts at revamping the GSEs. In 2014, the FHFA introduced the goal of developing a new securitisation infrastructure for Fannie and Freddie. Consequently, both are developing a Common Securitization Platform (CSP). The aim isthat the two GSEs will issue a common security.
The problem with the CSP is the further questions it would raise. “The CSP is designed to have Fannie and Freddie do things in the same way, although that would raise questions over why we have two separate entities,” said Cohen.
Politics as usual
Ultimately GSE reform, and the size of the government’s role in the RMBS market, is a policy question. “It’s the sort of question Congress needs to answer,” said Killian.
But the brake on policy is, as always, politics. “The short of it is, not a lot will be happening until after the election in 2016,” said Cohen.
Republicans are marginally more likely to tackle GSE reform than Democrats. The latter’s leading presidential candidate is very vocal about reforming Wall Street, but much quieter on GSEs.
“Hillary Clinton has felt the need to rattle her sabre at Wall Street, but so far as I know she has not suggested any GSE reform,” said Cohen. “Housing finance in the US ain't broke enough to fix,” he said.
KEY TAKEAWAYS
Counsel are considering the prospects for reforming government sponsored enterprises (GSEs);
Reformers want reduce taxpayer liability and boost the market for private label securities (PLS);
Legislative attempts at reform have failed, and GSEs won’t reform themselves;
Neither major political party in the US is likely to pursue GSE reform in 2016;
In early 2017, the GSE’s capital will be depleted and reform will become more urgent.
“The political wins from reforming GSEs are microscopic,” said Cohen. Still, any new US president will have the face the issue. And one motive for delaying GSE reform will soon be gone.
“The Dodd-Frank act mandated their resolution, but right now the government is still enjoying the capital it’s pulling out of them in the form of dividends,” said V Gerard Comizio, partner at Paul Hastings.
That’s soon to change. “As early as 2017, just as the new President is taking office, that capital could be depleted,” said Comizio. “Then you have to ask what to do with these two behemoths,” he added.
Limits to reform
Whatever the future of GSE reform, the US is unlikely ever to see a fully private mortgage market. “There’s likely always going to be a role for government, at a minimum, in FHA,” said Killian.
That’s because the US government is reluctant to kill a key platform of the American dream – home ownership. “The government wouldn’t allow mortgage credit to fully dry up,” said Killian.
In that respect, GSE reform is very similar to the other great government guarantee, too big to fail. That retreat from taxpayer liability is much trumpeted, but fundamentally unrealistic. The government’s guarantee in crucial markets, such as banking and mortgage credit, is simply too important.
“Realistically, the government is never fully off the hook,” Killian said.
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