Editor’s Note: This story was originally featured in the April issue of DSNews, out now.
Peter Wallison is the first to admit that his beliefs on housing policy may be controversial. However, having served as White House Counsel under President Ronald Reagan, as General Counsel of the U.S. Treasury Department from 1981 to 1985, and now as the Arthur F. Burns Fellow in Financial Policy Studies at the American Enterprise Institute, he has no problem fighting for his beliefs at the highest level.
Recently, Wallison took a bold stance by declaring the U.S. Treasury Department “rogue” in an op-ed for The Wall Street Journal. In the piece, Wallison voiced his confusion that the Treasury Department seems to be veering away from the Trump administration’s overall focus on deregulation.
In January, Secretary of the Treasury Steven Mnuchin stated that reform of the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac was a top priority for the Trump administration, but cautioned that it was important that the government continue to support the mortgage market. During a Senate Banking Committee hearing, Mnuchin expressed commitment to maintaining the 30-year fixed-rate mortgage backed by a government guarantee. “I don’t think the private markets on their own would support it. As we talk about GSE reform, we need to make sure we don’t do something that would put that at risk.”
However, he also stressed the importance of “substantial private capital” being involved in any new system, so as to limit taxpayer risk. “If there is any guarantee, [it is important] that taxpayers are paid for putting that up, as opposed to explicit guarantees that weren’t compensated in the past,” Mnuchin said.
Wallison’s stance is rather different. “I think the most important thing to understand is that the only reason for the government to be involved in the housing finance system is to help low and medium income families buy homes,” Wallison told DS News.
After the U.S. economy and the housing market endured the traumatic Great Recession, developing comprehensive policies on housing finance was a crucial aspect of reviving the economy. Now, between an administration that has taken a new stance toward financial policy and the continued fluctuation of the economy, it may be time to take a look at what regulations may need to be updated in the face of today ’s market conditions—controversial or not. To address this, we spoke to some of the industry’s greatest leaders about the lessons they learned during the housing crisis, and how it’s shaping their stance on financial policy today.
Characterizing the Post-crisis Era
Rep. Jeb Hensarling (R-Texas) has been one of the most outspoken proponents of reforming the GSEs, Fannie Mae and Freddie Mac, for some time now. During a December 2017 speech on housing reform, Hensarling didn’t mince words. “The current system is rigid and risky, distortive and inefficient, and it devalues individual choice and inhibits long-term prosperity. In other words, the hybrid GSE model is wrong. It is unfair. It is broken. It is irreparable. It cannot be saved, it cannot be salvaged, it must not be resurrected, and needs to be scrapped.” “A better system would give all Americans the chance to become homeowners,” Hensarling continued, “if they so choose and are qualified, in a way that encourages responsible mortgage lending and promotes long-term economic growth and stability.”
The Hon. Edward DeMarco served as the acting Director of the Federal Housing Finance Agency (FHFA) immediately following the crisis from 2009 to 2014 overseeing the conservatorship of the GSEs. Today, he serves as President of the Housing Policy Council at the Financial Services Roundtable. For DeMarco, this is a time that reminds him of the flaws in America’s housing finance system. “That period was a painful reminder of several things,” DeMarco said. “Your home should not be viewed as a piggy bank or even primarily as an investment. It is consumption.”
Additionally, DeMarco noted the need for transparency to make financial markets work, as too much of the housing finance system was opaque going into the crisis. However, DeMarco’s most thought-provoking lesson learned during his time at the helm of the FHFA is the reminder that concentrating economic activity on a few players, Fannie Mae and Freddie Mac especially leads to systemic risks.
“We should want more competition,” DeMarco explained. “We should want not fewer channels for lending and financing, but more. Another thing, it served as a reminder that encouraging leverage in household balance sheets that exceeds what we allow for banks, is curious public policy. It’s one that creates a lot of risks for households, and in the crisis, it led to terrible damage to the very households policymakers thought they were helping.”
DeMarco believes consumers and lenders are more risk-averse in the wake of these changes.
While that’s healthy, the negative of this is postcrisis regulations that arguably went too far and today may be limiting credit and innovation in the marketplace. What’s the cure? DeMarco urges establishing equilibrium and balancing regulations with extending credit and encouraging innovation. After the savings and loan crisis, most mortgage credit risks either ended up in a government guarantee program such as Federal Housing Agency (FHA) or Veterans Affairs (VA) or at Fannie Mae and Freddie Mac.
According to DeMarco, Fannie and Freddie retained virtually all the credit risk on $5 trillion of mortgages, while operating with a broadly perceived backing of the government. This was reinforced by remarkably weaker capital requirements set in statute, and weaker relative to what banks and thrifts faced.
Fundamentally, housing finance reform is about replacing that concentration of mortgage credit risk in two GSEs with a competitive private market for mortgage credit risk that seeks private capital through numerous channels and across many risk holders.
“The reason why I advocate for this change is that having multiple sources of capital is more resilient than having just two,” DeMarco said. “It better protects taxpayers, and it naturally leads to investor demand for transparency regarding the risk characteristics of the loans they are supporting. In turn, that should produce more accurate market signals of risk, which benefits both borrowers and lenders.”
Hon. Joseph Murin, Chairman of the Board of Chrysalis Holdings JJAM Financial Services, formerly served as President of Ginnie Mae, where his efforts ensured strong support for the housing market during the worst of the housing crisis. He served both the Bush Administration and the Obama Administration during his tenure.
“That was a difficult time in our nation and to the housing and mortgage industry,” Murin said. “You really don’t know what you’re getting into when you get into it because it’s almost a baptism by fire.”
Ginnie Mae’s monthly issuance that was between $7 billion and $9 billion started to grow rapidly and ultimately peaked at around $70 billion a month, which caused a lot of issues. When Fannie and Freddie were thrown into conservatorship, there was a lot of confusion in the marketplace. Foreclosures began to accelerate and the only liquidity vehicle available then was government loans through Ginnie Mae issuance.
“We didn’t have enough domestic buyers, so we had to depend on our Asian buyers to step up and buy more issuance every month, and it was a very turbulent time,” Murin said reflecting. “Obviously, at that time, the agency only had 69 employees, and we weren’t able to get any more employees authorized through the Department of Housing and Urban Development (HUD). So, I will tell you, it caused us a tremendous amount of angst every day in 2008 and 2009.”
At the beginning of the post-crisis era, Murin believes the political environment was demonized. “I think the industry was paying its repentance for its sins, but all we were doing was hurting the national economy because housing was at a standstill,” he said. Murin continued, “One thing I learned when I was in Washington is that the end term and consequences of your actions aren’t really understood. When you drop a pebble into a pond of water, those ripples touch all the shorelines, so you have to think about the repercussions when you do something, and sometimes I think that there’s a lack of that.”
But what stood out the most to the former Ginnie Mae President during the crisis? It was the resilience of the American people on any level, on anything.
“We went through a once-in-a-lifetime traumatic event in the 2008 time period that we saw some really important initiatives come to the forefront,” Murin said. “We saw folks working together because they knew what they were saving were the stability of the American government as related to its finances.”
Jack Konyk, Executive Director, Government Affairs, Weiner Brodsky Kider, has over four decades of financial services experience and serves as a voice for the industry with legislators and regulators at all levels of government. For Konyk, reflecting on the post-crisis era involves looking back at the different administrations.
According to Konyk, during the Obama administration, there was an extreme reaction to economic circumstances, some it deserved, and some of it not.
“There was a willingness upon a lot of the regulatory community to just blame the industry for everything that happened and crackdown, literally, on just about every practice they could find; which caused a great deal of angst,” said Konyk.
Of course, the industry was simply reacting to the economic realities of the downturn, but there were a lot of distractions in trying to respond. From lawsuits and regulatory actions to trying to interpret and implement regulations that were incredibly severe. “The industry just knew it was walking on eggs, but it didn’t know exactly where the safe paths were,” said Konyk.
As for the current administration, Konyk believes there is an indication that this administration is more willing to look at business as a positive partner in the operation of the economy and not necessarily the enemy. Although, this administration hasn’t been adept at making leadership appointments.
One of the greatest issues today, according to Konyk, is the need to place rational, reasonable, regulatory authorities and leaders in key governmental positions who will work toward establishing a marketplace that Americans can rely on, understand, and operate confidently in, without inadvertently causing massive risk to the companies.
For the Greater Good
In June 2017, DeMarco testified before the U.S. Senate Committee on Banking, Housing, and Urban Affairs during a hearing on, “Principles of Housing Finance Reform,” as President of the Housing Policy Council (HPC), a division of the Financial Services Roundtable. The HPC’s 32 member-firms are among the nation’s leading mortgage originators, servicers, insurers and mortgage data service and settlement providers. DeMarco testified that these leaders operate in the mortgage market every day and they want it to be healthy and stable for the future to serve their customers—current and future homeowners.
“As a trade association and especially one representing the largest players in the market, we seek what’s good for the system as a whole,” DeMarco said. “Competitive balance, effective and understandable regulations that align with good business practices, and opportunities for innovation in serving customers. When I was a regulator, I was concerned with similar end goals.”
Just as rulemaking and regulatory oversight involve balancing competing interests for the greater good, so does running a trade association that’s concerned with markets functioning efficiently and effectively. While there aren’t very many policy issues that are cut-and-dried, right and wrong—most inevitably involve trade-off s.
“I have come back to a core belief in markets and in basic economic principles,” DeMarco said. “Such as, the benefits of competitions, the importance in considering the incentives that laws and regulations can create, and maintaining some awareness of the law of unintended consequences.”
Today, the regulatory framework is undergoing a fresh round of thinking with the new administration and with the new regulators that are taking their seats. Regulators are looking to improve the balance between ensuring there are guardrails in place while making sure those guardrails are not, in fact, limiting access to credit and inhibiting economic growth.
“With affordable housing, the discussion is certainly developing. We’re seeing some new ideas emerging about how to encourage sustainable homeownership that’s affordable to folks,” DeMarco said. “The members of HPC see this as an opportune time to address three critical issues in Housing Finance.” Those issues are housing finance reform, improving the FHA program, and creating more opportunity for innovation and the use of technology in mortgage lending. “Each of these issues, dealing with them would enhance economic growth and expand opportunity for consumers,” DeMarco said. “They are enacting housing finance reform.”
Ending the conservatorships, giving market participants certainty about the role of government and the market structure in which they’ll compete. Second, modernizing FHA so that lenders may have confidence in how the program operates and can judge and manage the risks involved.
Lastly, more significant opportunity for innovation and the use of technology in mortgage lending. That would improve risk management. It would lower cost to borrowers. It would enhance product offerings. And, according to DeMarco, reduce the long and uncertain timelines many families face today in applying for a mortgage.
So in sum, the current focus remains on Housing Finance reform, improving the FHA program and creating more opportunity for innovation and the use of technology in mortgage lending.
Making dramatic changes to the housing finance system could cause concern for some. During a November 2017 hearing, Ginnie Mae Acting President, Michael R. Bright, spoke before the House Financial Services Committee, where he presented a paper he co-wrote with DeMarco in September 2016 titled, “Toward a New Secondary Mortgage Market.” In response, Rep. Brad Sherman (D-California) stated, “I don’t buy the idea that ‘if it’s not broke, don’t fix it,’ because sometimes you can make things better. But if it’s not broke, don’t break it.”
Sen. Elizabeth Warren (D-Massachusetts) has vigorously opposed some of the administration’s attempts to make changes to the Consumer Financial Protection Bureau and various Dodd-Frank regulations, but in the past she has indicated openness to GSE reform. During that same June 2017 Senate Banking Committee hearing, Warren said, “I am all for ending government conservatorship, but I can’t be for reform if it doesn’t address the affordable housing crisis in the country.”
As for the government involvement with the housing finance system, Murin believes that as long as the system establishes a secure government backstop, cost of liquidity can maintain itself. According to Murin, moving housing to the private markets will cause the cost of liquidity to go up. So there has to be a consistent abundance of credit available for all levels of borrowers in the marketplace at all times.
However, with a fair credit loss responsibility and accountability system that allows the government backstop to stay in place, Murin believes in the creation of a mortgage finance system that can meet the needs of every level of a borrower in the marketplace.
Tim Rood serves as Partner of The Collingwood Group, which he co-founded in 2009. Rood brings more than two decades of the mortgage industry and entrepreneurial experience to The Collingwood Group. He advises organizations to optimize the business opportunities and to mitigate and manage the risks in and around Washington, D.C.
Rood advises that the housing finance reform proposed is an “old wine in a new bottle” approach. “We need to look no further than the housing crisis to see how private label securitizers with similar product sets, pricing, and capital standards found themselves all rising together during the boom times, and then all crashing to the ground when the rug got pulled out from underneath them,” Rood said. “I fear that some of the things being proposed would set us up for that sort of outcome.”
There is a need to take into consideration that the GSEs are designed to be counter-cyclical, which, according to Rood, is critical to the housing market. In bad times, the GSEs will be in every market, every day, with competitive pricing, a facet that comes from their borrowing advantage and implicit guarantee by the federal government.
The GSEs can be borrowing competitively, freely all the time. Conversely, some argue that the newly proposed guarantor model would be pro-cyclical. Meaning that the model will work great during strong markets, but when there’s a shock to the system, the GSEs will find themselves challenged to borrow and effectively compete and provide financing.
“The things that we’re trying to accomplish in terms of insulating taxpayers, ensuring democratizing access for lenders to the financial markets and that gives pricing parities, already exists and that a couple modifications to the conservative share of the GSEs to make them look more like government utilities, seems to be far less risky than radical reform or wholesale reform that includes essentially hand-grenading these two institutions that have been profitable for years and are serving the market well, under the hopes that a new system will somehow at best be as competitive and as available as the current market system is today.”
Standing for Change
In Wallison’s view, most things outside of ensuring access to housing can be taken care of by the private sector, for example, automobiles and food. When looking at how the private sector operates in the United States in a very competitive way, most of the things that people want have very stable prices without the government’s involvement at all.
“This is an amazing thing that our market produces because of the competition that is involved in the private market,” Wallison said. “So why do we introduce the government into the housing finance system when almost everything else of importance in this country is run by and priced by the private sector?”
Wallison strongly urges that taking the government out of the housing system will stabilize housing prices and will provide more opportunity for housing while reducing the risk of another housing bubble. The competition between Fannie Mae and Freddie Mac competing with the FHA has been driving down underwriting standards so they can allow more low-income people to buy homes. However, Wallison believes that the result has been much higher home prices for everyone; especially low and moderate-income families who have been priced out of the market when they’re trying to buy their first home because prices have risen faster than their wages.
The private sector in this country produces goods and services at prices people can afford.
According to Wallison, there is nothing about housing that is any different from any other private sector. Housing is simply a product.
“Let’s see how the housing finance system works without the government and the distortions the government introduces. If we then find that low and moderate income families cannot afford homes, we should rely on some kind of narrow government program that applies only to those families and is run by the FHA,” Wallison suggests.
According to Murin, there can be room for an independent Fannie and Freddie that has a catastrophic backstop with the government but that also is fully responsible for the credit losses.
“We can’t merge the two, if Fannie and Freddie’s going to stand independently, then they’re going to have to be responsible for their own credit losses if they expect to have a government guarantee,” Murin said. “The explicit guarantee by the federal government is critical, I believe, in our mortgage lending environment. So, without that, the cost of mortgages goes up significantly.”
Speaking out, Murin urges the industry, when expressing policy ideals and perspectives, to realize how vital housing and the mortgage industry is to the American economy and to the American worker, especially the middle class and the lower to moderate middle class. “Everybody should be guaranteed a roof over his or her head,” Murin said. “I don’t necessarily think everybody should be guaranteed to own a home because that’s illogical but we have to focus on consistent mortgage credit for lower and moderate-income Americans to ultimately become a homeowner at some point in their life.” Murin continued, “Th at’s where our focus should be. Let’s start with the foundation, let’s rebuild the foundation, let’s commit to that foundation of stability with housing of some kind to bring that family unit back together.”
Turning Ideas into Action
According to DeMarco, the principles to base an ideal housing policy on are first, fix what’s broken and then preserve what works in support of consumers in the market. Second, the transition from the old system to the new one should avoid disrupting consumers and markets. Third, private capital should bear all but catastrophic mortgage credit risk, so that market discipline contains risk. DeMarco notes that the government should provide an explicit full facing credit guarantee on mortgage-backed securities (MBS), but with a preset mechanism to ensure any catastrophic loses that call upon taxpayers, support will be repaid fully.
Next, the government should provide a regulatory framework that is clear and equitable across all participating companies and ensures that participants in the housing finance system operate in a safe and sound manner. Additionally, replace the government protected GSE duopoly with a structure that serves consumers by promoting competition, affordability, transparency, innovation, market efficiency, and broad consumer access to a range of mortgage products.
Replace the separate Fannie Mae and Freddie Mac MBS with a single deep and liquid MBS that has multiple issuers, backed by private capital, and wrapped with a government guarantee. And implement the common securitization infrastructure that operates with a uniform set of standards for mortgage servicing, investor disclosure, and dispute resolution.
Finally, change the approach to meeting affordable housing goals by utilizing a dedicated funding stream to target individual households where policymakers want to promote a homeownership opportunity. “Targeting those resources in a way that leads not just to more homeowners, but to more sustainable homeownership,” DeMarco said. “It also means modernizing FHA, which needs to be an integral part of this discussion of affordable and sustainable homeownership.”
For Konyk, the major principles that must turn into action should be that, first, consumers are informed and then empowered to make their own choices, without a lender having to assume all the responsibility that the borrower may have made a bad choice.
“That’s an interesting concept because even in Dodd-Frank, this concept appeared to be clear because they actually created in the CFPB an office of financial education. So they got that, as a country, we’ve done a bad job of educating people in how to exist in the economy.” Konyk continued, “What we need to do is to understand first, that it is a free economy, or at least we purport it to be. Borrowers should be empowered to make choices, and then lenders shouldn’t be penalized for offering choices, as long as they offered them honestly, openly, and with the information necessary for an informed borrower to make a free choice. Those principles don’t seem to be working in a lot of places right now.”
The role of the CFPB itself has been very much in question in recent months after President Trump appointed White House Budget Director Mick Mulvaney as Acting Director of the organization. There followed a legal dispute between Mulvaney and CFPB Deputy Director Leandra English, who was appointed to the same role by outgoing CFPB Director Richard Cordray.
With both parties claiming they were the rightful inheritor of the position, the decision turned to the courts, which backed Mulvaney through several appeals and challenges. Mulvaney, a longtime critic of the agency, has set a very different course for the CFPB.
He requested zero funding for the Bureau during Q2 2018 and in February announced a strategic plan for 2018-2022 that emphasized honoring the Bureau’s statutory responsibilities but going “no further.” In a statement at the time, Mulvaney explained that “pushing the envelope in pursuit of other objectives ignores the will of the American people” and “also risks trampling upon the liberties of our citizens.”
Unsurprisingly, this scaling back of the CFPB’s regulatory focus has drawn ire from Sen. Warren, who was an advocate for the creation of the CFPB and a staunch defender of it ever since. She has butted heads with Mulvaney over the proper role of the CFPB, criticizing Mulvaney for scaling back investigations into things such as payday lending practices.
Warren has also been pushing back recently against the bipartisan Economic Growth, Regulatory Relief, and Consumer Protection Act, which would scale back some of the regulations put in place by Dodd-Frank after the financial crisis.
One of the primary changes is increasing the threshold for enhanced regulatory standards from $50 billion to $250 billion, a change designed to exempt some smaller and mid-sized banks from regulations that would still apply to the larger banking entities. The bill also exempts banks with less than $10 billion in assets from the Volcker Rule, which limits risky trading by U.S. banks, and dials back restrictions on small and regional banks when it comes to restrictions on mortgage lending. As the bill headed toward a final vote in the Senate, Warren warned that “If we lose the final vote next week, we’ll be paving the way for the next big crash. It’s time for the rest of us to fight back and demand that Washington work for us, not the big bank lobbyists.”
Overall, the industry needs to look at the weaknesses in certain things, but it isn’t the same as saying, “Well, we’ve always done it this way, so this must be good.” Instead, it needs to say, “Look, this may be better. Here are the pitfalls. Here are the safeguards against them. And this is how we should be moving forward.” Konyk strongly urges that despite the current active market, without taking action and fixing the problems now, the next downturn will come and cause panic again.
“You don’t want to fix them in a panic. The time to fix them is now.” And the only way to do so is if policymakers from different parties, views, and perspectives can get to the table without the animosity. The housing system will only reach progress out of frank, open conversation and the understanding that each side has its reasons for its beliefs.
“The way we get ahead in this country is we realize that we’re not going to get everything we want,” Konyk said. “But, we need to find the way to get the optimum solution, understanding that there’s got to compromise to move forward. We’re not in that frame of mind right now in any of the pairings that you talk about. We just have to find a way to get by it.”