WASHINGTON — Two top Obama administration officials said Tuesday that the government-sponsored enterprises would not be exempted from a pending proposal to help standardize mortgages sold into the secondary market.
Department of Housing and Urban Development Secretary Shaun Donovan and Treasury Secretary Tim Geithner signaled that the GSEs would have to comply with a plan that forces lenders to retain 5% of the credit risk of loans they sell unless they qualify for a safe harbor that establishes strict underwriting standards. "Everything we've said in this discussion today about reform of the GSEs would suggest that we are very much in favor of ensuring that the GSEs are holding adequate capital against their commitments," Donovan told the Senate Banking Committee. "I actually do not think there are discussions about exemptions."
During the hearing, Geithner also voiced support for the creation of a covered bond market in the U.S. and continued to dodge questions on a specific proposal for the future of Fannie Mae and Freddie Mac.
Regulators have yet to release the risk-retention proposal, but early reports had suggested the GSEs would be exempted temporarily while they remained in conservatorship. But Geithner suggested that would undermine the goal of the plan, which is to broadly set industrywide standards governing mortgage securitization.
"Our overall objective, and this has to be our shared objective, is to have the private markets — the banks and the investors — bear more of the risk in housing finance, not less of the risk," Geithner said. "So absolutely we want to make sure as we design these draft regulations that we're meeting that basic objective. We don't want to be working against that basic objective."
Republicans had raised concerns that the GSEs could be exempt from the plan, potentially adding to government losses from its bailouts of Fannie Mae and Freddie Mac. In response to a question from Sen. David Vitter, R-La., Donovan sought to address those fears.
"If we are setting standards for risk retention that should cover the market broadly, and the question is, how do we ensure whether it is the GSEs or any other kind of financial institution that they are holding adequate capital?" Donovan said.
Donovan stressed that the definition of a "qualifying residential mortgage" — which is exempt from the risk-retention requirements — would be key.
"One of the clear problems that led us into the crisis in the first place was a sort of patchwork of various standards or lack of standards that applied across different types of mortgages," Donovan said. "One of the important elements of the QRM is that it would hopefully level that playing field rather than continuing the patchwork that we saw before."
The risk-retention plan had been expected to be released as early as Tuesday at a Federal Deposit Insurance Corp. meeting after bank regulators struck a deal on the inclusion of servicing standards into the proposal. But because of the sheer number of other agencies involved — it must also be approved by HUD, the Securities and Exchange Commission and the Federal Housing Finance Agency — the FDIC did not discuss the plan and it has yet to be made public.
Speaking on the future of housing finance, Geithner also threw his support behind legislation introduced by Rep. Scott Garrett, R-N.J., to establish a legal framework for a covered bond market.
"We also believe it is appropriate to consider additional means of advance funding for mortgage credit as part of the broader reform process, including potentially developing a legislative framework for a covered bond market," Geithner said.
Covered bonds are touted as an alternative to securitization, in which loans leave the originator and are packaged into securities sold on the secondary market. Instead, the mortgages behind covered bonds stay on a bank's balance sheet. The collateral is refreshed with new loans if the original assets stop performing.
Geithner hastened to add that the U.S. already has a covered bond market provided by the Federal Home Loan Banks' finance system and acknowledged the "very legitimate" concerns raised by the FDIC. The agency warned last week that a covered bond system could benefit the largest institutions at the expense of community banks.
"For this to work you would be putting the taxpayer, in some sense, behind private investors, and that has its own consequences. But that is something we can work through, and I think it could play a greater role in our system," Geithner said.
Donovan cautioned that the creation of a U.S. covered bond market would not serve as a "silver bullet."
"It is important that we create the conditions for more innovation in the system. I do think though it's important to point out as well, given that GSE obligations are the second-largest securities market in the world, there really is no precedent for covered bonds operating in a market as broad and deep as the U.S. market," Donovan said. "So I think it's an important element but I don't think as some have suggested that it's sort of silver bullet, if you will, or replacement."
Sen. Charles Schumer, D-N.Y., who raised the issue during the hearing, said he was considering introducing legislation in the Senate to set up a covered bond market.
During the hearing, lawmakers continued to push the administration to offer a concrete outline for the future of Fannie and Freddie. The administration issued a white paper last month that offered three options, but Geithner has refused to endorse a single approach.
"I'm one of those folks that believes we work best when the administration lays out something clear, and then we offer editorial comment here," said Sen. Bob Corker, R-Tenn. "We would like adult supervision."
But Geithner again declined to say if the administration preferred a particular option.
"I'm going to disappoint you and not answer that question directly at this stage," Geithner said. "I do think that after a period of debate and discussion and further exploration of these options then I think it would make sense for us to tell you what we think makes sense, what's the best mix, what's the best alternative."
Under the white paper, option one calls for the government to significantly dial back government support, leaving just the Federal Housing Administration and a few other targeted programs to help low-income borrowers. Option two would follow a similar route, but calls for the development of a government guarantee that could scale up in bad economic times and reduce during boom times.
Option three would allow a group of private mortgage companies to provide guarantees for mortgage-backed securities that meet certain strict underwriting criteria. A government entity would then provide reinsurance to the holders of the securities, which would only be paid if shareholders were entirely wiped out. The government would charge a premium for its reinsurance that would be used to offset losses to taxpayers.
Geithner said these options must be weighed against the impact they would have on the concentration of the mortgage market, particularly for community banks, the flexibility required to protect the economy and taxpayers, and moral-hazard risk.
"In any guarantee, you need to make sure you separate it from political influence from banks, from real estate communities, from other people with — however noble their objectives are — so that you can price it and redesign it so the taxpayer isn't too exposed to the risk of loss," Geithner said.
He said that Congress needs to draft legislation within a two-year time frame.
"Without new legislation to allow us to wind them down definitively there is a substantial risk," Geithner said. He suggested it would take five to seven years to completely unwind both GSEs. "If we don't legislate, the risk is we're more likely to face the system where they get re-created in a different form."