Barriers exist to full-blown recovery in the housing market. Structural barriers. Economic barriers. Regulatory barriers. The list is endless.
Nowhere is this truer than in the secondary mortgage market. The continued disinterest in private-label mortgage-backed securities, in today’s environment is contributing to the slow recovery. Many investors do not trust that the existing frameworks provide them enough protection to make it worthwhile for them to invest in MBS.
The result, consistent with the laws of supply and demand, has been a paucity of new RMBS issuance. The void has been filled by more Fannie Mae and Freddie Mac securitizations. And while constant debate swirls around Capitol Hill regarding the futures of the GSEs, there is significant doubt that the near 90% stranglehold the government has on the mortgage market will dissipate anytime soon.
However, if we were to find a way to restore investor confidence and address regulatory uncertainty, private capital would likely emerge from the sidelines.
The future of the GSEs is one of the first areas that must be addressed. The Senate Banking Committee recently released a legislative proposal from Chairman Johnson and Ranking Member Crapo which seeks to addresses their role and future place in the market. This proposal, while not perfect, reflects many of the ideas that have been proposed by industry stakeholders. It lays out a path to end the conservatorship for Fannie Mae and Freddie Mac, create new entities and creates a new regulator, the Federal Mortgage Insurance Corp., which would provide an explicit government backstop for certain mortgage-backed securities.
Such a move would be welcome. The greater assurance that would come with a clear end-game for the federal role in housing finance will allow private capital to begin examining the potential size and nature of the nonagency market.
Looking at the scalability of the market, it is evident that a lack of trust in the ratings agencies is also preventing private capital from flourishing. Previously, the level of dependence on the agencies encouraged institutional investors to invest in the comparatively low yield of AAA tranches of RMBS. Conversley there was a perceived lack of risk. However as the losses on these tranches escalated, trust evaporated from the market and with it, significant participation from private capital. Unfortunately while some have returned, AAA investors largely remained inactive.
Regulatory issues resulting from recently finalized rulemakings are also playing a role in reducing investor interest in private MBS. The substantial increase in regulatory compliance costs across the mortgage market and resulting uncertainties where rules interact are a cause for concern. Increased efforts to reduce uncertainty around future rulemaking and to better align existing regulations would benefit this market.
Specifically, Dodd-Frank's risk retention rule and proposed amendments to Reg AB disclosure rules remain unfinished. The industry has advocated that the definition of a qualified residential mortgage that would be exempt from risk retention requirements, be aligned with that for the qualified mortgage that is deemed to have met Dodd-Frank’s “ability to repay” standard. Finalizing the rule by aligning these definitions would reduce uncertainty for issuers with respect to the marketability of new pools.
Also, the new disclosure framework of Reg AB will require a substantial investment to ensure compliance, leaving potential investors hesitant to move forward until the cost is known. Until these and other issues are worked out, private capital will be hesitant to engage.
One of the largest potential investors in private MBS is the banking industry. However, Basel III as implemented provides a disincentive for banks to invest in less liquid securities, while providing a strong incentive to invest in high quality loans. Not surprisingly, banks are reacting to these incentives and providing a strong bid for prime credit quality mortgages, particularly jumbos. Until the playing field is leveled, banks will remain on the sidelines with respect to private MBS purchases.
Few would argue that the housing market has been one of the bright spots in the overall economic recovery. But with refinances drying up and interest rates rising, the future for a vibrant, competitive mortgage market that best serves all borrowers, is in doubt. As such it is imperative that we entice private capital to fully reenter the market by eliminating uncertainty and reducing risk. Doing so will create a dynamic, stable housing system, to the benefit of all involved, for years to come.
David Stevens is the president and CEO of the Mortgage Bankers Association.
