House Financial Services Subcommittee Issues Testimony From BlackRock
"Chairman Duffy, Ranking Member Cleaver and members of the Subcommittee, thank you for the opportunity to testify today on the important topic of housing finance reform. My name is
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"Over the past nine years, there have been significant changes in the housing and securitization markets, as well as critical changes to
* significant reductions in the size of the GSEs' portfolios,
* enhanced underwriting guidelines,
* increased guarantee fees,
* innovative structures for introducing private sector credit enhancement including a new Credit Risk Transfer (CRT) market,
* revised representation and warranty requirements,
* the ongoing implementation of a Common Securitization Platform and
* the development of a common form of mortgage-backed security that could be traded with a single TBA contract.
"Further, the environment for the housing market and housing finance has changed dramatically during the post-Crisis period, and relative to the previous Congressional attempts at reform. Housing prices in most markets across the country have recovered, with some exceptions.
"Since the financial crisis, policymakers have contemplated an array of proposals for what the next iteration of the housing finance system could look like. While
Specifically, these principles are as follows:
"Any conversation on housing finance reform should begin with a discussion of its potential impact on borrowers and the availability of long-term fixed-rate credit products.
"Any legislation should articulate a clearly-defined government role in the mortgage market that focuses on ensuring uninterrupted liquidity in secondary markets for mortgage-backed securities (MBS).
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"A government guarantee should be structured to protect taxpayers from an undue amount of risk through private-sector risk sharing arrangements.
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"In addition, to further reduce taxpayer risk over the long-term,
"Finally, any legislative reforms to the housing finance systems should be undertaken in a deliberate and thoughtful way, including an orderly transition from the current system to the new system and fungibility of existing GSE MBS with any future MBS.
We will now discuss each of these principles in more detail.
"Any conversation on housing finance reform should begin with a discussion of its potential impact on borrowers and the availability of long-term fixed-rate credit products. For most Americans, the purchase of a home is the most significant purchase they will undertake over the course of their lives and for the vast majority, a 30-year fixed-rate mortgage may make the most sense. As such,
"The primary focus of
"Homogeneity is what makes the TBA market succeed. Because securities are sold in advance, buyers and sellers agree on certain terms of a trade, but buyers do not know - and do not need to know - all the characteristics of the security they have purchased. Instead, buyers receive information about the security two days before the trade settles. Today, mortgage origination terms are standardized through the GSEs. GSE-mandated standards help create homogeneity in terms of form (structure and payment dates) and underlying contractual provisions (documentation, pooling, servicing, and disclosure). These standards mean that investors can purchase MBS in the TBA market with confidence that these securities will meet a certain minimum standard of quality regardless of who originates the mortgages.
"Any legislation should articulate a clearly-defined government role in the mortgage market that focuses on ensuring uninterrupted liquidity in secondary markets for MBS. A vibrant secondary market will benefit all market participants - borrowers, originators, lenders, investors, and intermediaries - and clarity on the government's role will allow all market participants to hedge the risks that accompany their position in the market, and for the private sector to develop around it. A clearly-defined government role will also help attract private capital to the mortgage market and help rebuild the market for private-label MBS.
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"This explicit and appropriately priced guarantee will maintain liquidity and confidence in the secondary market, reduce interest rates for borrowers, and encourage investors to supply credit by allowing them to focus on prepayment and interest rate risks. Absent a government guarantee, the market will be required to price credit risk -including catastrophic credit risk - into mortgage interest rates, which will reduce the availability of credit and weaken investor appetite for even the safest MBS. The guarantee will also provide critical countercyclical support for the market in times of crisis, and allow investors to fund mortgage credit creation during contractions of private capital availability. In 2008, as the private-label MBS market receded and banks withdrew, the GSE and FHA markets continued to facilitate loans. If the GSE and FHA markets had not been able to step into the downturn, mortgage credit would have completely dried up and many Americans would have effectively been unable to purchase homes.
"A government guarantee should be structured to protect taxpayers from an undue amount of risk through private-sector risk sharing arrangements. The government should require that for a MBS to qualify for a guarantee, it must have levels of private capital in front of the guarantee to protect taxpayers, including borrower equity and fees paid by lenders to obtain a guarantee. Additionally, intermediaries should be required to conduct CRT to ensure that taxpayer exposure is focused on catastrophic risk, not first-loss risk. We believe the adoption of both front and back-end CRT by the GSEs has been an important step towards a safer secondary market.
"It is also important that any credit risk sharing not have a pro-cyclical impact on the availability of credit. Requiring fixed levels of risk sharing or setting mandatory amounts of CRT for intermediaries to conduct for a given security could cause insurance premiums to rise in periods of market stress, hurting the availability of credit at the worst possible time. Instead, targeted levels of risk sharing should include off-ramps and provisions that allow regulators to temporarily adjust or suspend requirements should market conditions dictate this.
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"Today,
"While the GSEs have been in conservatorship for nine years, the enterprises and FHFA have undertaken important administrative actions that have improved the soundness of the entities and the durability of the housing finance system broadly. We believe these reforms - or some equivalent version of these reforms - should be preserved under any new system and applied to or used by future intermediaries. We have already mentioned the CRT program, and the GSEs have begun modernizing their securitization infrastructure, which was needed given the age of existing GSE systems. This Common Securitization Platform will likely be a valuable asset in any future system.
"In addition, to further reduce taxpayer risk over the long-term,
We believe there are a few key principles here:
* Investors in private label MBS need to understand what they are buying, through clear and transparent disclosure and clearly defined rights and obligations of transacting counterparties that is as standardized as is reasonable, and through the establishment of more nationally uniform rules around activities such as mortgage servicing as opposed to the hodgepodge of rules that exist today at the national, state, and local levels.
* Investors need to trust that rules of the game will not change after the fact; for example, that their rights will be respected in policy actions including legal and regulatory settlements, or that their investments will not be threatened by irresponsible abuse of eminent domain.
* Investors need to believe that policymakers share the goal over the long term of creating a vibrant and liquid non-government mortgage securitization market. Investors will not return in size to these markets unless they believe the markets will be around for the long term.
"Finally, any legislative reforms to the housing finance systems should be undertaken in an orderly and thoughtful way, including an orderly transition from the current system to new system and fungibility of existing GSE MBS with any future MBS. There is tremendous downside risk of a disorderly transition, and turmoil in the housing market would penalize Americans in the market for a home. In our view, policymakers focused on creating a new system should be just as mindful of how we transition to the new system as they are on what the new system will look like. There is currently over
"In the secondary market, the best way to ensure a safe and orderly transition is to assure investors that existing GSE MBS will be fungible with any future MBS. Abandoning outstanding securities could irreparably harm confidence by investors for new securities, and any security would launch with no liquidity - a dangerous outcome for all market participants, including borrowers. It is possible that the transition period is necessarily a lengthy one, but we believe that to ensure the smooth functioning of our markets, it is better that the transition be long and cautious, as missteps could harm investor confidence in the new system and create serious distortions in the housing market.
"In conclusion, the current circumstances are very different from 2008 when the GSEs were first placed into conservatorship, and we are now in a better place. The housing markets have largely recovered, the financial conditions of the GSEs has stabilized, and the GSEs have undertaken a number of important reforms. That said,
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