House Financial Services Subcommittee Issues Testimony From Structured Finance Industry Group
"Chairman Duffy, Ranking Member Cleaver and members of the Subcommittee, thank you for the opportunity to testify today. My name is
"It is with that mission in mind that I thank you for this opportunity to address the Committee regarding housing finance reform, including finding an appropriate balance of private and public funding in the housing finance system. While the overall economic environment, and housing finance in particular, has recovered substantially since the crisis nearly 10 years ago and home prices in most markets have largely recovered, private capital's role in that recovery has been comparatively small, in historical terms, in relation to the government's role. The disproportionately large role of the government in today's housing finance system is the outcome of many factors but it is inarguably in an unhealthy condition. We believe this condition can be remedied, but reforms should be done in a manner which provides for a smooth transition that minimizes market volatility and maintains access to credit.
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"Any considerations of housing reform should encourage a healthy and sustainable mix of publically-supported and privately-supported funding sources, eliminate hidden or implied guarantees or subsidies which might distort costs, and minimize risk to the taxpayer and the economy. While we strongly encourage steps to restore the private label securitization market because it removes risk from taxpayers, diversifies economic risk, encourages economic innovation, and ultimately reduces borrowing costs, we also believe that the continued presence of publically-supported funding is essential to provide counter-cyclical stability, act as a source of 30 year fixed mortgage credit to the consumer, and support the To-Be-Announced (TBA) market and support affordable housing goals.
In Support of a Government Guaranty
The TBA Market
"The distinguishing traits of the TBA Market are the government guaranty and the homogeneity of the offered securities (i.e., standardized underwriting criteria and loan features, the geographic diversification incorporated into the pooling process, the limited number of issuers, the simple structure of "pass-through" security features, and the restriction of the range of interest rates on loans deliverable into a single security). The parties to the trades agree only on certain criteria of the securities to be delivered: issuer, maturity, coupon, price, principal balance, and trade settlement date. The actual securities to be delivered at trade settlement are not specified on the date the transaction is executed. Rather, just before the settlement date, the seller notifies the buyer of the specific securities that will satisfy the TBA agreement.
"The elimination of credit risk and homogeneity have created the TBA market, with trading approaching
"The TBA Market also provides a more direct and noticeable benefit to the housing markets, it is the most efficient and cheapest mechanism to enable a mortgage consumer to "lock in" the interest rate at the time when a mortgage loan is approved and thereby minimize the cost of borrowing. Because TBA buyers are indifferent as to the specific securities delivered, originators are able to easily and inexpensively cover their hedges should they originate less collateral than expected in any given period, significantly reducing the cost to hedge and rate lock. The TBA Market creates efficiencies and cost savings for lenders that are passed on to borrowers in the form of lower rates.
"Moreover, homogeneity is what makes the TBA Market possible, specifically, the fungibility of the conforming loan product (through standardized underwriting criteria and loan features) and a government guarantee, which equalizes credit risk. Additionally, due to the specific exemption from
"Furthermore, as the GSEs move ahead with the roll-out of the Common Securitization Platform (CSP) and the Uniform Mortgage Backed Security (UMBS) particular care and consideration should be paid to facilitate the standardization of MBS instruments that receive an ultimate government guarantee in order to ensure the continued functioning of the TBA Market. The transition from the status quo to a new housing finance structure must be transparent, appropriate to market conditions, and handled with great care to minimize any disruptions to the flow of credit to consumers, and ensure the continued functioning of a healthy TBA Market. Of utmost concern is that steps must be taken to allow the fulfillment of existing commitments (including contracts for future delivery) and preserve the market for legacy securities (i.e., outstanding government-guaranteed MBS), while allowing sufficient time for eligible loans under the reformed system to be generated and take hold in the TBA Market.
30-year Fixed Rate
"I would like to speak briefly about the benefits of the 30-year fixed rate mortgage and its reliance on government support. Without the backing of the Federal government, it is unlikely that the 30-year fixed-rate mortgage, which remains an essential financing tool for homebuyers, could exist in the
Counter-cyclicality and Providing Credit through Market Downturns
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The Role of
GSE CRT Program
"At the outset of my testimony I stressed the importance of the appropriate mix of public and private support for the housing finance system. Over the past decade, publically-supported funding has played an outsized role in supporting the market, which has diminished the role of the mortgage credit investor and the private capital provided by such investors. While private capital has entered the market in the form of portfolio lending, this channel represents a smaller pool of capital than the fixed income markets, and serves to concentrate mortgage credit risk on the balance sheets of a few lenders rather than distribute it throughout a broad base of investors. Clearly much work remains to be done to restore a more healthy balance to these funding sources.
"One area where there has been notable success in the reintroduction of private capital into the risk taking spectrum is via the GSEs CRT programs.
"The former PLS market offered these deep pools of capital to fixed income investors in the form of investment grade securities, increasing liquidity and ultimately helping lower consumer borrowing costs.
Reviving the PLS market
"As noted above, the PLS market once represented a far greater share of the mortgage funding ecosystem. Market excesses and bad actors across the mortgage market led to the collapse in housing that fed the Great Recession. In response to that crisis, legislation and regulations were put in place with the goal of preventing the kinds of excesses we witnessed a decade ago.
"While these laws and regulations were intended to reduce risk and prevent the dynamics and behaviors that led to the crash they were, in some instances, overly broad or created uncertainty.
"This contributes to the current reality wherein some historically credit-worthy borrowers are unable to access credit because investors are neither willing nor able to provide capital that had previously been invested in mortgage credit risk. The end result is that many of the people who were hurt by the housing collapse now find themselves unable to benefit from the ongoing housing recovery.
"In response to the crisis, the Dodd-Frank Act and resulting regulatory reforms were imposed to provide greater protection and stability to the housing market and economy. Largely, these reforms did not touch the GSEs, resulting in capital shifting towards the publicly supported market and away from the private market, as a result of the burdensome rules that were placed on that market. As this committee is considering housing finance reform and ways to attract that private capital, policymakers should review those policies which may have created an uneven playing field or inadvertent biases.
"One such area is capital relief for non-GSE issuers of CRT, i.e. banks. Currently, it is very difficult for depository institutions subject to regulatory capital rules entering into similar transactions to be able to recognize the benefits of having transferred risk to third-parties. In most circumstances the capital reserved against the risk associated with such a transaction is greater than the required capital to be set aside for the loans themselves. Industry observers generally agree that, consistent, with common-sense, the amount of capital required to protect against loss in the system should be decreased when risk is transferred.
"Another area worthy of consideration is highlighted in the Treasury Report - A Financial System That Creates Economic Opportunities, dated
"A more straightforward way to encourage expansion of the PLS market is by lowering the conforming loan limits of
"The industry itself is working to revive the PLS market.
Conclusion
"The issues confronting the Committee as it considers reforms to the housing finance system are critical not only to the health of the nation's housing market, but to the growth of the nation's economy generally. While we recognize the need to correct the errors of the past, we urge the Committee not to lose sight of the ways in which the Agency Market has worked well and the potential opportunities to re-invigorate the PLS market, all in the service of facilitating a more robust, liquid, competitive, and stable housing market.
"We look forward to working with the Committee as it considers these vitally important issues. Thank you again for the opportunity to share
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Footnotes:
1 https://www.urban.org/sites/default/files/publication/93516/sep_chartbook_final_1.pdf
2 Ibid.
3 https://www.finra.org/sites/default/files/Analysis_of_Securitized_Asset_Liquidity.pdf
4 https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr468.pdf
5 https://www.fhfa.gov/aboutus/reports/reportdocuments/crt-overview-8-21-2015.pdf
6 https://www.treasury.gov/press-center/press-releases/Documents/A%20Financial%20System.pdf
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