70212_RecommendationsfortheFutureGovernmentRoleintheCoreSecondaryMortgageMarket

8/14/2019 70212_RecommendationsfortheFutureGovernmentRoleintheCoreSecondaryMortgageMarket

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MBAs RECOMMENDATIONS FORTHE FUTURE GOVERNMENT ROLE

IN THE CORE SECONDARY MORTGAGE MARKET


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2 Recommendations for the Future Government Role in the Core Secondary Mortgage Market rom the Council on Ensuring Mortgage Liquidity Mortgage Bankers Association August 2009. All Rights Reserved.

INTRODUCTION

Since the creation o Fannie Mae in the 1930s, the ederal government has played a key role in providing

stability to the secondary mortgage market. The current housing crisis has tested the governments role

and led to calls or a undamental rethinking o how the government plays its part.

To provide in ormation and insights to this rethinking, in October, 2008 the Mortgage Bankers Association

(MBA) established the Council on Ensuring Mortgage Liquidity. The Councils mission has been to look

beyond the current crisis, to what a unctioning secondary mortgage market should like or the long term.

On November 19, 2008, the Council hosted a summit on the uture o the secondary mor tgage market

and the GSEs that brought together leading thinkers rom industry, academia and regulators to discuss

what undamental elements would be required or a unctioning secondary market. The discussion led

to the Council-issued report Key Considerations or the Future o the Secondary Mortgage Market and

the Government Sponsored Enterprises (GSEs), which was released in January, 2009.

The Councils second task was to develop a set o guiding principles embodying the key considerations

mentioned in the primer. The report Principles or Ensuring Mortgage Liquidity was released by the Council

on March 19, 2009. The principles serve as a tool or evaluating proposals that arise or restructuring

the secondary market.

As the policy spotlight has turned to the utures o Fannie Mae and Freddie Mac, the Council hastaken on the questions o what an appropriate uture government role in the core secondary mortgage

market might look like. A ter thought ul discussions and deliberations, we now present the Councils

Recommendations or the Future Government Role in the Core Secondary Mortgage Market.

This report presents the Councils suggested ramework or government involvement in the single- amily

and multi amily secondary mortgage markets, with a particular ocus on the roles currently played by

Fannie Mae and Freddie Mac. While clearly not the only potential ramework or the uture, the Councils

recommendations represent a clear, concise and workable approach to ensuring liquidity to the mortgage

market. The proposed ramework care ully balances the governments ability to ensure liquidity with the

need to protect taxpayers rom credit and interest rate risks associated with mortgage nance. This and

the other Council reports can be ound at: www.mortgagebankers.org/CEML.


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Recommendations for the Future Government Role in the Core Secondary Mortgage Market rom the Council on Ensuring Mortgage Liquidity 3 Mortgage Bankers Association August 2009. All Rights Reserved.

In the coming months, MBA and the Council will continue to study the critical issues related to the uture

o the secondary mortgage market, and will continue to provide in ormation and insights to regulators,

legislators and others involved in the policymaking process. We want to thank the members o the

Council or their valuable service, and or helping de ne a workable model or the uture government

role in the secondary mortgage market.

John Courson Michael Berman, CMBPresident and Chie Executive O cer President and Chie Executive O cer, CWCapital

Mortgage Bankers Association Vice Chairman, Mortgage Bankers AssociationChair, Council on Ensuring Mortgage Liquidity


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COUNCIL ON ENSURING MORTGAGE LIQUIDITY MEMBERS

Council Chairman

Michael D. Berman, CMBPresident and Chie Executive O fcer CWCapital

Vice ChairmanMortgage Bankers Association

Council Members

Richard A. AneshanselExecutive Vice President

and Chie Financial O fcer, Finance U.S. Bank Home Mortgage

Jon K. BaymillerExecutive Vice President AmTrust Bank

Phillip W. BrackenExecutive Vice President Wells Fargo Home Mortgage

Garry CipponeriSenior Vice President Chase

Timothy C. Dale, CMBExecutive Vice President BB&T

Peter F. DonovanSenior Managing Director CBRE Capital Markets

Robert GaitherSenior Vice President Government Lending Executive

Bank o America Home Loans

S. A. IbrahimChie Executive O fcer Radian Guaranty Inc.

Curt G. JohnsonVice ChairmanFirst American TitleInsurance Company

John B. Johnson, CMBPresident and Chie Executive O fcer MortgageAmerica Inc.

Richard D. Jones, Esq.Partner Dechert LLP

David H. KatkovPresident and Chie Operating O fcer PMI Mortgage Insurance Co.

Rodrigo Lopez, CMBPresident and Chie Executive O fcer AmeriSphere Multi amilyFinance, L.L.C

Regina M. Lowrie, CMBPresident and Chie Executive O fcer Vision Mortgage Capital, LLC

Peter F. MakowieckiPresident and Chie Executive O fcer

MetLi e Home Loans

Phoebe MoreoPartner Deloitte & Touche, LLP

Kieran P. Quinn, CMBVice ChairmanWalker & Dunlop, Inc.

Diana ReidExecutive Vice President PNC Real Estate Finance

David A. Roberts, CMBPresident and Chie Operating O fcer Grandbridge Real EstateCapital LLC

Theodore TozerSenior Vice President,Capital Markets National City Bank

Bruce W. WilliamsChairman and Chie Executive O fcer HomeStreet Bank

Michael W. YoungChairman o the Board Cenlar FSB


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1. OVERVIEW

The importance o housing in the economic and social abric o the United States warrants a ederal

government role in promoting liquidity and stability in the market or mortgage debt. The size and scope

o the U.S. housing market mean that, except in times o extreme duress, the ederal governments roleshould be to promote liquidity or investor purchases o mortgage-backed securities, not to attempt to

provide the capital or or absorb the risks itsel . 1

As a necessary component o this provision o liquidity and stability, a security-level credit guarantee

backstop will be needed or the core mortgage market, 2 which should rely on security-level risk-based

premiums paid into a ederal insurance und and loan-level guarantees provided by a small number o

privately-owned, government-chartered and regulated mortgage credit-guarantor entities (MCGE). The

government backstop should be explicit and should be ocused on the credit risk and market liquidity

o mortgage-related products, not any interest rate risk. The loan-level MCGE guarantee should be such

that it absorbs all mortgage-related credit losses and that the ederal insurance und is called upon only

in situations o extreme distress.

The centerpiece o ederal support or the secondary mortgage market should be a new line o mortgage-

backed securities. Each security would have two components: a) a security-level, ederal government-

guaranteed wrap (GG) like that on a GNMA security; which would in turn be backed by b) private,

loan-level guarantees rom privately owned, government-chartered and regulated mortgage credit-guarantor

entities (MCGEs). The GG would be conceptually similar to the Ginnie Mae model and would guaranteetimely interest and principal payments to bondholders, would explicitly carry the ull aith and credit

o the U.S. government and would be supported by a ederal insurance und, ueled by risk-based ees

charged or the securities at issuance and on an ongoing basis. The MCGEs would in turn rely on their

own capital base as well as risk-retention rom originators, issuers and other secondary market entities

such as mortgage insurers. Through these programs, the credit risk o the underlying mortgages would be

removed rom the securities issued, while the interest rate risk would remain with the security investor.


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2. MORTGAGE CREDIT-GUARANTOR ENTITIES (MCGE)

The MCGEs should be privately owned, mono-line institutions ocused solely on the mortgage credit

guarantee and securitization business. This business encompasses both single- amily and multi amily

residential mortgages. The loan-level MCGE guarantee would be backed by private capital held by theMCGEs which would be overseen by a strong regulator. The MCGEs would be required to manage their

credit risk by using risk-based pricing, originator retention o risk (such as reps and warrants backed

by su cient capital to support them), private mortgage insurance (PMI) and risk trans er mechanisms

including other risk-sharing arrangements, to ensure that there is a strong capital bu er be ore the GG

and insurance und would come into play. Loans would not be included in a GG security unless they

were guaranteed by a MCGE.

In most cases the MCGEs would own the loans underlying the GG securities they issue, and in the event

o oreclosure could own the real estate collateral.

The MCGEs would have standard corporate powers to raise debt and equity. Other than access to the

related GG security they could issue, none o the corporate debt or equity the MCGEs issue would be

guaranteed, either explicitly or implicitly, by the ederal government. The corporate capital levels o the

MCGEs must be actuarially sound and the entities should report regularly to the satis action o the GG,

Treasury and the MCGEs regulator.

The number o MCGEs should be based on the goals o a) competition, b) strong and e ective regulatoryoversight, c) e ciency and scale, d) standardization, e) security volume and liquidity, ) ensuring no one

MCGE becomes too big to ail and g) the transition rom the current government sponsored entity (GSE)

ramework. Initially, the number o MCGEs should be either two or three. The regulator would have the

ability to increase that number over time, through the granting o charters, as the market develops. The

ownership o at least one o the MCGEs could be in a co-op orm with mortgage lenders as shareholders.

The governance structure o the MCGEs should adequately represent both the multi amily and single-

amily mortgage markets.


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Allowable Mortgage Products of the MCGEs

The ederally related securitization guarantee should support only core mortgage products with well-

understood, well-documented risk characteristics. The ederally related securitization guarantee should

generally support: a) conventional single- amily mortgage products traditionally supported by the GSEs,

including those currently eligible or TBA unding; and b) multi amily mortgage products that t the GSEs

published underwriting guidelines, including a ordable multi amily rental housing mortgage products. I

CRA-related loans are included in the de nition o core products, the MCGEs and GG should provide a

transparent and liquid market into which lenders can deliver them on a pricing and risk-adjusted basis.

In de ning the products covered by the new guarantees, industry participants, the MCGEs, the GG

and ederal regulators should care ully review current product de nitions and classi cations to ensure

maximum market transparency, e ciency and liquidity. New products would be proposed by the MCGEs,

recommended by the GG and would require approval rom the regulator. Thus new product developmentwould be measured, prudently regulated and conservatively responsive to market demands.

Portfolio Authority

The key mission o the MCGEs should be to guarantee and securitize mortgages through the program

described. The MCGEs should there ore hold only a de minimus port olio o mortgage assets. 3 The

port olios purposes would be to support securitization by allowing the MCGEs to a) aggregate allowable

mortgages or securitization, b) manage loss mitigation through oreclosure, modi cations and other

activities, c) incubate mortgages that may need seasoning prior to securitization, d) develop new

mortgage products through a strictly limited level o research and development prior to the development

o a ull-fedged securitization market and e) und highly structured multi amily mortgages that are not

conducive to securitization.

Regulator

The MCGEs regulator should be strong, empowered and adequately unded through the GG insurance

premiums. 4 The regulation regime contemplated would be similar to that o a public utility, with the

MCGEs earning a conservative return on equity. The regulator should have the power to adequately

oversee the MCGEs, speci cally with regard to products, pricing and capital adequacy.


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3. FEDERAL GOVERNMENT GUARANTEED

WRAP (GG) SECURITIES

GG securities would carry a guarantee o timely interest and principal payment, would explicitly carry

the ull aith and credit o the U.S. government and would be supported by a ederal insurance und,ueled by risk-based ees charged or the securities at issuance and on an ongoing basis. Ginnie Mae

could potentially take on the responsibilities o the GG.

The GG would be responsible or standardization o mortgage products, indentures and mortgage

documentation or the core mortgage market. Minimum regulated ees would be established or ongoing

servicing, surveillance and reporting. This would ensure standardization and liquidity throughout the core

market. Each MCGE would individually issue GG securities under this standardized regime. These new GG

securities could also be issued by private institutions approved by the MCGEs. These securities would also

carry the GG security-level guarantee backed by the MCGE loan-level guarantee; accordingly, the MCGEs

will have approved and insured the underlying collateral.

The GG is not intended to support the entire mortgage market, but rather only those products needed to

keep the secondary market or core mortgage products liquid and unctioning through all environments.

There would continue to be key roles or FHA, VA, RHS and Ginnie Mae as well as or the ully private

market, particularly as such roles evolve in support o public or social housing policy goals and objectives.

FHA, VA, RHS and Ginnie Mae would continue to play critical roles in providing government credit support

or a ordable housing, while the ully private market would provide nance vehicles or mortgages thatall outside o core product pro les. Mortgages made outside o a ederally guaranteed ramework would

rely entirely on private capital and management o risks, in as much as such mortgages may exhibit

risk characteristics that would not be well documented or well understood (and there ore would not be

allowable products eligible or inclusion in GG securities).

The mission o any ederally related mortgage securitization and guarantee program should be explicitly

limited to ensuring liquidity in the core mortgage market through the issuance and guarantee o mortgage-

backed securities. 5 This important mission should not be distorted by additional public or social housing

policy goals. To the degree additional objectives are desired, they should be pursued through FHA, VA,

RHS, Ginnie Mae and direct ederal tax and spending programs, which should be adequately unded and

supported to meet these important objectives. The sel -supporting GG ederal insurance und, which is

likely to run surpluses in all but the most extreme circumstances, could be a potential source o unds or

Congress when considering a ordable housing expenditures.


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While the ull aith and credit o the U.S. government should mean there will not be a need or a liquidity

backstop, in times o extreme market distress, liquidity could be provided to the GG securities market through

Treasury and/or Federal Reserve purchases o GG mortgage securities. 6 As a result, there would not be a need

or the MCGEs port olios to be sized and structured to take on the role o liquidity providers o last resort.

4. TRANSITION

The in rastructure o the existing GSEs should be used as a oundation or new MCGEs, with the

technology, human capital, standard documents and existing relationships that the GSEs have developed

available to one or more MCGEs. Every e ort should be made to trans er existing origination, servicing

and other industry relationships rom the GSEs to the new MCGEs so as not to strand originators and

servicers with ties to the existing GSEs. Historical per ormance data and other in ormation should be

made available to originators, the MCGEs, regulators, rating agencies, investors and providers o credit

support to enhance the e ciency o the market.

Decisions regarding the utures o the GSEs should be made expeditiously so as to reduce continued

losses o talent at Fannie Mae and Freddie Mac. This will be important both to maintain the ongoing

management o the GSEs existing books o business as well as to ully leverage their in rastructures

or use by the new MCGEs.

In order to acilitate a more rapid transition, to maximize the use ulness o the existing in rastructure

o the GSEs and to allow the ederal government to continue to use that in rastructure to address the

current housing market challenges, a good bank/bad bank resolution o the GSEs, their assets and

liabilities should be considered.


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Federal governmentguarantor (GG)

Banks/mortgage lenders

Mortgage creditguarantor entities

(MCGE)

Core loans throughgovernment guarantee

market

Government creditsupport loans through

FHA, VA and RHS

Non-core loansthrough fully

private market

Retained on bank/otherportfolios or private-

label issuance

Ginnie Mae-guaranteed

MBS

Risk-basedcapital

Risk-basedinsurance

fund

GGMBS

Loan-levelguarantee

Security-levelrisk-based

insurance fee

Strongsurveillance

and regulation

Security-levelguarantee

1 2 3

8

5

6

7

4

1. Mortgages are originated.

2. Mortgages are submitted toMCGE for credit underwritingand pooling.

3. MCGE prices and holds capitalfor the credit risk of the loans.

4. MCGE guarantees timelypayment of principal andinterest of the loans.

5. Federal agencies provideoversight, regulation andsecurity-level guarantee inexchange for risk-based fee.

6. GG guarantees timely paymentof principal and interest of thesecurity.

7. MCGE or mortgage lender issuesGG security to the market.

8. Based on the GG guarantee,security trades in equivalenceto full faith and credit of theU.S. government; security buyertakes all the interest rate risk.

HIGH-LEVEL VIEWTARGET STATE: POTENTIAL ROLE OF THE FEDERAL GOVERNMENTIN THE CORE SECONDARY MORTGAGE MARKET

Federal government

Banks/mortgage lenders

Conformingloans through

GSE market

Government creditsupport loans through

FHA, VA, RHS and GSEs

Non-conforming loansthrough fully

private market

Retained on bank/otherportfolios or private-

label issuance

Ginnie Mae-guaranteed

MBS

GSE-guaranteed

MBS

Security-levelguarantee

1 2 3

8

5

6

7

4

1. Mortgages are originated.

2. Mortgages are sold to FannieMae or Freddie Mac (FM).

3. FM prices and holds capitalfor the credit risk of the loans.FM either holds the loan inportfolio or includes it in MBS.

4. FM guarantees timely paymentof principal and intereston MBS.

5. Federal agency providesoversight and regulation.

6. FM or mortgage lender issuesFM-guaranteed security to themarket.

7. Based on special status of theGSEs, security trades at apremium to other MBS.

8. FM may also purchase theirown or other GSE-issued,

Ginnie Mae or private labelMBS as well as non-conventional government creditsupport loans to hold inportfolio, taking both thecredit and interest rate risks.

HIGH-LEVEL VIEW

CURRENT STATE: FANNIE MAE, FREDDIE MACAND THE SECONDARY MORTGAGE MARKET

Fannie Mae andFreddie Mac

Portfolio: $1.6 trillion(as of 05/31/09) Risk-basedcapital


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NOTES

1. The Mortgage Bankers Associations Council on Ensuring Mortgage Liquidity. Principles or Ensuring

Mortgage Liquidity . March 2009. 1.a. Except or times o extreme market stress, and except or

the availability o a credit guarantee program as described in section 7 below, secondary markettransactions should be unded by investors seeking market returns and who take on the credit, interest

rate and / or other associated market risks or market-derived yields.

2. Ibid. 7. There is a role or a government credit-guarantee program to help attract investment to the

residential secondary mortgage market.

3. Ibid. 7.c. Any government sponsored entity or program should preclude the creation o a GSE-like

investment port olio assembled or the purpose o arbitrage pro ts. A GSE or GSE-like entity may

require a port olio to support its securitization activities (i.e. aggregation, incubation, innovation), to

accommodate limited amounts or highly structured products not conducive to securitization and / or

to maintain an in rastructure or serving as a liquidity backstop or the market.

4. Ibid. 5.c. The regulator o any government sponsored / owned entity and other secondary mortgage

market regulators should be strong, empowered and adequately unded.

5. Ibid. 8.a. The government should balance and coordinate any pursuit o social policy goals through

the secondary mortgage market operations o government sponsored / owned entities with theirimplications or sa ety and soundness, the e cient operation o the secondary mortgage market

and their consistency with primary mortgage market and / or other requirements. Such policy goals

should be limited to residential housing in a way that does not contain market distortions.

6. Ibid. 10.a. In times o extreme market stress, the government should provide a mechanism to step

into the secondary mortgage market as a liquidity provider o last resort by providing a liquidity

backstop. MBA is currently developing a working brie discussing the merits o this approach.


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70212_RecommendationsfortheFutureGovernmentRoleintheCoreSecondaryMortgageMarket

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