Over the past few months we have begun to see what might be in store for the GSE’s going forward. On the one hand, many are praising the pledge to end the conservatorship, viewing this move as something that will protect the current model over the long term. On the other, some are raising concerns about some of the potential for adverse side effects that might result from the moves ahead.
Lets start with the basics. The GSE’s have been one of the most stable sources of capital to support the housing system this last decade despite a Great Recession and todays current risks in the bond and repo markets and perhaps an impending economic slowdown ahead. Having them in conservatorship, some could argue, has shielded them from what might be greater volatility.
There are other factors in play as well. While Director Calabria trumpets the potential modification to the sweep, in order to retain capital in exchange for having the US Government receive greater share holdings in the companies, as reported by the Wall Street Journal, there are potential disruptions to small lenders, low down payment borrowers, multi family rental property, and mortgage backed security (MBS) investors. All of this could result in a shift of power from non bank lenders and smaller depositories to on-balance sheet buyers of mortgages. The beneficiaries could include large banks, some REIT’s, and the new entrants like Angel Oak and others who can leverage the private market to disintermediate the GSE’s themselves.
For small lenders, regardless of capitalization and a pathway to release, the real question is whether the GSE and perhaps FHA footprints will narrow. Should the regulator determine that the GSE’s are “crowding out private capital”, something Director Calabria seems to have already concluded, then we may see moves that will shrink the role the GSE’s play. This could include a variety of options one of which would be to simply price out the GSE’s against private industry execution, or modifying loan purpose or other terms, potentially forcing smaller lenders and non banks to move back into correspondent lending to larger players or simply reducing their volume altogether relative the scope of products and terms we see today.
For low downpayment borrowers, many of whom are minority first time homebuyers, the housing reform plans from both the Treasury Department and HUD call for entry level “affordable” mortgage programs to be shifted to HUD in their entirety. It further calls for the GSE’s not to overlap the programs at HUD and vice-versa. Their papers explicitly raise questions about both low downpayment loans and down payment assistance loans. These two features are valued tools for younger buyers who do not have the benefit of inherited wealth or large gifts and may be simply put on the sidelines of homeownership opportunity. This would particularly adversely impact minorities.
For multi family developers and lenders, the FHFA has stated concerns as to whether these programs are crowding out private capital. They recently revised the caps, increasing the total but eliminating the highly utilized “green” exemption, something that virtually any apartment building established in the last decade or so likely qualified for. Those companies that depend on the GSE’s for this business have cried foul, arguing that the MF programs were not the culprit in the demise of Fannie and Freddie prior to conservatorship and should not be punished by these moves. But conservative policy makers are arguing a different point, focusing on the appropriate role of government programs in the real estate finance system with statements suggesting that the role today is outstretched.
Finally there are MBS investors who have been agitating as to whether recap and release, without a clearly legislated explicit backstop, will equate to the kind of commitment that exists today in conservatorship. The $200+ billion line of credit was put in place to give global investors confidence in the MBS. Depending on how this is all treated in a forward looking recap and release process, absent of legislation, could result in a loss of confidence from some investors. Keep in mind, all the hyperbole in the world won’t matter in this case. Many foreign sovereigns are prohibited from investing in anything less than triple A securities. If any of them view these instruments as less than that, this would raise rates as investors would demand a higher return. While there is much debate here, it has considerably adverse implications if bonds are downgraded.
The pathway ahead is clearly bullish for the non agency market and positive for an increase in private capital to the system. Balance sheet investors that view the GSE’s as competition will likely be winners. Even if marginal, the size and scope of this market can be significant to them. What’s important here though is to consider the tension points that may be impacted, whether intentional or not. Highlighting some of those is part of a steady drum beat that stakeholders need to keep emphasizing in order to be helpful to the Administration, HUD, and FHFA as they head down this path.
Bottom line? Recklessness, or simply moving too quickly, is a risk. The devil we know today, two GSE’s in conservatorship, at least works and is critical to the complicated and interwoven relationships that begin with a homebuyer and ends in a global universe of investors. Administrative reform, absent legislation, is not the formula that many stakeholders called for because of things like the points stated here. We all have an obligation to be vigilant in our advocacy for attention to detail and avoiding unnecessary adverse outcomes.
The question today is whether the devil we know is better than devil we don’t. That remains to be seen.