The commission’s report goes into considerable detail about the individual components of the housing finance system we envision. It describes the structure and responsibilities of the public guarantor that will administer the limited catastrophic backstop. And it outlines the roles of the other actors in this new system—the originators, mortgage servicers, issuers of securities and the private entities that will “credit enhance” these securities.
The commission recommends a model similar to Ginnie Mae, where approved lenders are the issuers of mortgage-backed securities. The functions of an issuer of securities include:
Obtain certification from the public guarantor that it is qualified to issue MBS based on such factors as ability to meet credit and capital standards and cover all of the predominant loss risk through a separate well-capitalized credit enhancer, and capacity to effectively pool mortgages.
Ensure that the guarantee fee is paid for and collected from the borrower along with all other fees and fully disclosed to the borrower as a part of originating the mortgage.
Issue the mortgage-backed securities and, where appropriate, sell the MBS to investors through the to-be-announced market.
Retain responsibility for representations and warranties under the terms specified by the public guarantor.
The TBA market was established in the 1970s with the creation of pass-through securities at Ginnie Mae. It facilitates the forward trading of MBS issued by Ginnie Mae, Fannie Mae, and Freddie Mac by creating parameters under which mortgage pools can be considered fungible. On the trade date, only six criteria are agreed upon for the security or securities that are to be delivered: issuer, maturity, coupon, face value, price, and the settlement date. Investors can commit to buy MBS in advance because they know the general parameters of the mortgage pool, allowing lenders to sell their loan production on a forward basis, hedge interest rate risk inherent in mortgage lending, and lock in rates for borrowers. The TBA market is the most liquid, and consequently the most important, secondary market for mortgage loans, enabling buyers and sellers to trade large blocks of securities in a short time period.
Under our proposal, servicers would need to be qualified by the public guarantor. Responsibilities of a servicer include:
Make timely payment of principal and interest should the borrower be unable to do so. The servicer will advance the timely payment of principal and interest out of its own corporate funds and will be reimbursed by the private credit enhancer at the time the amount of the loan loss is established.
Work with the borrower on issues related to delinquency, default, and foreclosure and advance all funds required to properly service the loan.
The commission’s proposed single-family housing finance system depends on credible assurance that private institutions will bear the predominant loss credit risk, will be capitalized to withstand significant losses, and will provide credit that is generally unrestricted with little leverage. As such, private credit enhancers will bear the risk on the mortgages they have guaranteed until they go out of business or have met their full obligation, as defined by the public guarantor, to stand behind their guarantee. Private credit enhancers will generally be single-business, monoline companies and will be required to:
Provide regular reports to the public guarantor on the nature of the credit enhancement, who holds the risk, the amount and nature of the capital they hold, and other measures of credit strength. These measures would include a quarterly stress test to determine that available capital is adequate, with a “capital call” to assure there are sufficient reserves to protect the government guarantee from being tapped except in extreme cases.
Establish underwriting criteria for the mortgages and mortgage pools they will be guaranteeing beyond the baseline underwriting criteria established by the public guarantor.
Reimburse servicers for their timely payment of principal and interest and other costs at the time the amount of the loan loss is established. This reimbursement is paid out on a loan-by-loan basis until the private credit enhancer runs out of capital and goes out of business.
Establish and enforce servicing standards (in conjunction with national servicing standards) in order to ensure that the interests of the private credit enhancer and servicer are fully aligned.
Provide credit enhancement with standard, transparent, and consistent pricing to issuers of all types and sizes, including community banks, independent mortgage bankers, housing finance agencies, credit unions, and community development financial institutions.
Meet credit enhancement requirements through one or a combination of the following options: (1) well-capitalized private mortgage insurance at the loan level for any portion of the loan where specific capital requirements are established and the servicer and/or public guarantor has the ability to demand margin calls to increase capital if there is an adverse move in house prices; (2) capital market mechanisms where the amount of capital required to withstand severe losses is reserved up front, either through a senior/subordinated debt model with the subordinated piece sized to cover the predominant risk or approved derivatives models using either margined credit default swaps or fully funded credit linked notes; and (3) an approved premium-funded reserve model, where a premium-funded reserve is established, either fully capitalized at the outset or where the reserve builds over time.
These approaches to meet capital requirements are designed to ensure that private capital will stand ahead of any government guarantee for catastrophic risk. The public guarantor will establish the minimum capital levels required to survive a major drop in house values and will require any private credit enhancer to have sufficient capital to survive a stress test no less severe than the recent downturn (e.g., a home price decline of 30% to 35%, which would correspond to aggregate credit losses of 4% to 5% on prime loans).
Under the commission’s proposal, the public guarantor would guarantee the timely payment of principal and interest on the MBS, but this guarantee would be triggered only after all private capital in front of the guarantee has been expended. The guarantee would be explicit, fully funded, and actuarially sound, and the risk would apply only to the MBS and not to the equity and debt of the entities that issue and/or insure the MBS. Other functions of the public guarantor would include:
Establish the level of capital necessary to ensure that private-sector participants in the housing finance system (issuers, servicers, and private credit enhancers) are all properly capitalized.
Establish the guarantee fees to be collected from the borrower to cover the operating costs of the public guarantor and to offset catastrophic losses in the event of a failure of the private credit enhancer and/or servicer failure. For both the single-family and rental housing markets, a reserve fund would be established for catastrophic risk that will build over time.
Ensure the actuarial soundness of the funds through careful analysis and the use of outside expertise, and report to Congress regularly regarding their financial condition.
Ensure access to the government-guaranteed secondary market on full and equal terms to lenders of all types, including community banks, independent mortgage bankers, housing finance agencies, credit unions, and community development financial institutions. The public guarantor must ensure that issuers of securities do not create barriers using differential guarantee-fee pricing or other means to unfairly restrict or disadvantage participation in the government-guaranteed secondary market.
Provide one common shelf for the sale of government-guaranteed securities to offer greater liquidity for the market as well as establish an equal playing field for large and small lenders.
Establish a single platform for the issuing, trading, and tracking of MBS. With multiple private issuers, this platform could provide greater uniformity and transparency, and therefore lead to greater liquidity.
Create and enforce uniform pooling and servicing standards governing the distribution of mortgage proceeds and losses to investors and ensuring compliance with relevant federal tax laws.
Encourage loan modifications when a modification is expected to result in the lowest claims payment on a net present value basis. The public guarantor should require participants in the new government-guaranteed system to structure and service securities in a way that would facilitate such loan modifications.
The commission envisions the establishment of a single public guarantor with responsibility for both the single-family and rental housing markets. The public guarantor would consist of two separate divisions each with responsibility for administering its own separate catastrophic risk fund. Each division would also establish its own approval standards for lenders, issuers, servicers, and private credit enhancers as well as underwriting standards, predominant loss coverage requirements, and catastrophic guarantee fees.
In the commission’s view, the public guarantor should be established as an independent, wholly owned government corporation. As a government corporation, the public guarantor will be a self-supporting institution that does not rely on federal appropriations but rather finances the two catastrophic funds and its own operational expenses through the collection of guarantee fees. The public guarantor should operate independently of any existing federal department and, with this greater independence, should be able to respond more quickly to contingencies in the market and operate with greater efficiency in making staffing, budgeting, procurement, policy, and other decisions related to mission performance.
The commission recommends that the public guarantor be led by a single individual, appointed by the president of the United States and confirmed by the U.S. Senate, who would serve a director. The commission also recommends the establishment of an advisory council to the public guarantor consisting of the chairman of the Board of Governors of the Federal Reserve System as chairman of the council, along with the director of the public guarantor, the secretary of the Department of the Treasury, and the secretary of the Department of Housing and Urban Development. The advisory council would meet on at least a quarterly basis to share information about the condition of the national economy, marketplace developments and innovations, and potential risk to the safety and soundness of the nation’s housing finance system.
While the new housing finance system proposed by the commission will minimize taxpayer risk, this protection will come at the cost of higher mortgage rates for borrowers. Three factors will contribute to the added costs:
First, our proposal calls for a far greater role for the private sector in mortgage finance, with private capital taking the predominant loss risk and standing ahead of a limited government guarantee. Private credit enhancers will charge a fee to cover the cost of private capital to insure against the predominant loss if a mortgage default occurs.
Second, the public guarantor will charge an unsubsidized fee to cover catastrophic risk should a private credit enhancer be unable to fulfill its obligations to investors.
Third, the public guarantor will be structured as an independent, self-supporting government corporation that finances its activities through an operating fee.
The borrower will indirectly pay for all three of these activities through a guarantee fee that is included in the mortgage rate.
Mel Martinez is co-chair of the Bipartisan Policy Center's Housing Commission, a former HUD secretary and a former U.S. senator from Florida.
