The congressional stalemate over housing finance reform has left looming questions about the scope and enforcement of other bank regulations already in the pipeline.
The fate of Fannie Mae and Freddie Mac is comingled with various other regulatory provisions stemming from the crisis. Most notably, the Consumer Financial Protection Bureau's underwriting overhaul—known as the qualified mortgage rule—and the separate pending risk retention requirement for securitizers both allow government-sponsored enterprise-backed loans substantial flexibility while Fannie and Freddie are still in conservatorship. How long they stay open also affects how long banks can use GSE-issued securities to comply with new capital and liquidity rules.
With the legislative effort largely stalled, that means it is unclear just how long Fannie- and Freddie-eligible loans—which still make up a huge portion of the market—will be exempt from the new mortgage rules. Observers said the delay could lead to calls for regulators to revise or hurry up new standards to allow more participants not enjoying the exemptions to compete with the federally-supported mortgage giants.
"An indefinite extension of the status quo for GSEs could re-raise some of the question marks on the design of QM over time," said Jo Ann Barefoot, chief executive of Jo Ann Barefoot Group. "QM has this enormous question mark at the center of it, which is: What would happen if we didn't have the GSE provision in place that automatically qualifies loans [backed by Fannie and Freddie] as QM loans? Its future is tied to GSE reform, for sure."
Laurence Platt, a partner at K&L Gates, said an "indirect" result of the delay in GSE reform is it puts an onus on officials to finish rules that could help govern a private-label securitization market, which has struggled to re-establish following the mortgage meltdown. Those include the new risk retention standard, which several regulators are now in the process of trying to finalize. (Both the QM and risk retention rules were mandated under the Dodd-Frank Act.)
"The indirect impact is that it does heighten the pressure on securitization reform," Platt said. "At least for the foreseeable future, Fannie and Freddie are still going to take a large part of the market."
Although a bill that would replace the GSEs with a government insurer to create a new secondary mortgage market was approved by the Senate Banking Committee earlier this month, it appears unlikely to come to the Senate floor due to opposition from six key Democrats. Lawmakers and administration officials are said to be working still to gain support for the legislation sponsored by committee Chairman Tim Johnson, D-S.D., and ranking Republican Mike Crapo of Idaho.
But without backing from liberal members of the Democratic caucus, including Elizabeth Warren of Massachusetts and Sherrod Brown of Ohio, the bill is unlikely to advance to the Senate floor before midterm and presidential election politics begin to distract Congress from moving forward on anything. That has led to a growing consensus that Fannie and Freddie will continue to operate as wards of the Federal Housing Finance Agency—possibly for years to come.
Despite the lack of resolution on the GSEs' future, policymakers have still pushed ahead with new curbs on the mortgage market in the wake of the 2008 meltdown. The CFPB rule, which the bureau finished in January 2013 and became effective a year later, creates a new ultra-safe class of mortgages. QM loans must have low points and fees, lack risky features such as negative amortization, not exceed 30 years and have a debt-to-income ratio of no more than 43%.
But the rule allows GSE-backed loans to have higher DTIs and still be considered QM. The exemption lasts either as long as Fannie and Freddie are still in conservatorship or until January 2021, whichever comes first. (The exception also applies to loans backed by the Federal Housing Administration, the Department of Veterans Affairs and the Department of Agriculture.)
Similarly, the proposed risk retention rule, which generally requires securitizers to keep a 5% piece of loans sold to the secondary market, basically exempts loans that have a full guarantee from Fannie or Freddie for as long as the two mortgage giants are still in conservatorship.
The risk retention rule also includes a special designation of safe mortgage—known as the "qualified residential mortgage," or QRM—that absolves securitizers from the retention requirement. Regulators have proposed aligning the definition of QRM with how the CFPB has defined QM.
Platt said regulators should finish the risk retention rule sooner rather than later if non-GSE players are going to have a chance to compete. He said there is also a need for the Securities and Exchange Commission to move quickly on expected changes to Regulation AB, which governs disclosure, reporting and offering requirements for asset-backed securities.
"As long as Fannie and Freddie continue to have the dominant place in the marketplace, it’s going to be harder for securitization to come in, even though there is a greater need for securitization,” Platt said. "We really need to finalize Reg AB, and we need to finalize QRM."
Barefoot said an indefinite future for Fannie and Freddie—resulting in a longer exemption from the DTI limit in QM—could put pressure on regulators to consider steps for non-GSE-backed loans to compete.
"Right now, there is interdependency between the existence of the GSEs and the fragile new QM world that we’ve entered," she said. "The rule does tend to increase the attractiveness of the GSEs' secondary market because of the automatic coverage.
"If their future were indefinitely unclear, it would increase the concerns of those who don’t want the whole market to be relying on the GSEs. That in turn could put pressure back on to the regulators to make it easier to qualify for QM without necessarily selling" loans to Fannie and Freddie.
In May 2013, the FHFA announced it was limiting Fannie and Freddie loan purchases to mortgages that had the QM product features, but it would still allow purchases of loans with DTIs above 43% that enjoy the special treatment.
"Current Fannie Mae and Freddie Mac guidelines make some of these loans eligible for purchase when the borrower has other compensating strengths," FHFA Director Melvin Watt said in a May 13 speech at the Brookings Institution. (Watt was confirmed for the job in December.) "FHFA will continue to permit these compensating factors in each company's underwriting standards. As part of our ongoing safety and soundness obligations, we will, of course, continue to monitor performance data relating to these factors."
Some observers say the exception for Fannie and Freddie-backed loans allows the market to gradually phase in to the QM standard.
"The administration is still pushing pretty hard to try and come up with some further movement on a GSE bill, although I think it's still a long shot. What that means is more stability in the short run in the mortgage market," said Michael Calhoun, president of the Center for Responsible Lending. "People are going to have a little bit of time to absorb the flood of changes that have come over the last few years. Mel Watt has made it clear he is going to continue loans above 43% DTI, subject to compensating factors. We believe those are good signs. The market needs to get stabilized and recover and expand some before a lot of other changes are imposed on it."
Robert Davis, an executive vice president of the American Bankers Association, said policymakers may even preserve the flexibility in complying with QM when it ultimately creates a new housing finance structure.
"My assumption is there will probably be some revisiting of that flexibility in the 43% DTI test if Congress coalesces around something to establish a new structure to replace Fannie and Freddie," said Davis, who said he believes GSE reform will be finished before the 2021 deadline in QM. "If there is consensus that that debt-to-income flexibility is important with Fannie and Freddie, I think there is a high likelihood that a new structure would accommodate something similar to that flexibility. That could be done either through legislation or by the CFPB with proposed regulatory changes."
Others say a prolonged exception from the new rules for GSE-backed loans should have been expected.
Edward Mills, an analyst at FBR Capital Markets, said the CFPB's seven-year expiration for the special QM category for GSE-backed loans was likely based on prospects for how long housing finance reform could take. He said the bureau would likely extend the special treatment for Fannie and Freddie loans if reform is still not completed by 2021.
"The unexpected thing over the last year was that GSE reform seemed to even have a shot," Mills said. "The regulators wrote these rules as if GSE reform was not going to happen."
Meanwhile, the apparent stalling of GSE reform also has implications for regulations not directly tied to the mortgage market. In rules implementing international Basel capital and liquidity rules, U.S. regulators have classified debt securities issued by Fannie and Freddie as among the "high-quality assets" banks can use to comply. They are also viewed as a form of collateral institutions can use to comply with swaps margin requirements. With concerns spreading that the market may suffer a shortage of such high-quality assets amid so many new rules, a further delay in legislative action to unwind Fannie and Freddie, for the time being, ensures that those assets will still be there.
"The whole capital framework is premised on the conservatorships. It’s the same thing with the liquidity rules," said Karen Shaw Petrou, managing partner of Federal Financial Analytics. "Whoever starts issuing RMBS that wasn’t Fannie or Freddie would not get the same favorable capital weighting. The same thing is true in the liquidity rules, where agency paper is given a preferred status and other forms of mortgage-backed securities get no favorable treatment at all."
Yet Petrou stressed that that does not justify continuing the current GSE framework.
A delay in reform "reduces the market impact of having fewer high-quality assets, but only at the cost of preserving fragile government-sponsored enterprises and a nationalized housing finance system," she said. "The longer-term policy consequences of the continued conservatorships weigh heavily against the regulatory relief that might provide."