Anyone who's been following economic and financial policy news for the past two years knows that the government's role in the financing of housing is in need of a serious makeover. Action is needed to attract private capital back to the mortgage market, re-establish a self-sustaining mortgage financing system and allow more people to access the credit markets and once again realize the dream of sustainable and responsible ownership of a home or multifamily property.
The question is: How will policymakers do it? Indeed, how should they help stabilize a $12 trillion market that, if not properly reformed, could easily prolong — or even worsen — the "Great Recession"?
The answer: Very carefully. As with any major national issue, reforming the mortgage market system will be contentious and complex. It's important that industry officials, lawmakers and policymakers — many of whom are attending an Aug. 17 "mortgage summit" hosted by the Treasury Department and HUD — take time to think about regulations before creating them.
Members of the Mortgage Bankers Association will be attending and participating in this summit — and we have been thinking about improving the government's role in real estate finance for years. About a year ago, we created a proposal to solve this important issue. Here are the principles around which our proposal was built:
• Secondary mortgage market transactions should be funded with private capital. This helps limit the potential burden on taxpayers and allocates risk to the private sector.
• In order to promote uninterrupted market liquidity for the core of the mortgage market, the government should provide an explicit credit guarantee on a limited class of mortgage-backed securities. This guarantee should be paid for through risk-based fees on those who create the securities.
• Taxpayers and the system itself should be protected through strong regulation on the mortgage products covered, limitations on the types of activities undertaken, strong risk-based capital requirements and actuarially fair payments into a federal insurance fund. In other words, the MBA envisions this fund as something similar to deposit insurance under the Federal Deposit Insurance Corp.
In addition, we concluded that despite the need for change, some aspects of the mortgage market — namely, the 30-year, fixed-rate mortgage — should remain in place.
Americans view the 30-year, fixed-rate mortgage as the product standard. Payments are relatively low and predictable, and borrowers are protected from fluctuations in interest rates. Borrowers take the risk that the value of their largest asset may decline, but are protected from interest rate risk. In order to maintain the availability and affordability of the 30-year, fixed-rate mortgage, we believe the U.S. needs a vibrant secondary market where investors can focus on and manage interest rate and prepayment risks, while being shielded from the uncertainties surrounding mortgage credit risk.
With these principles in mind, last September we released our proposal for what we believe should be the government's role in the secondary mortgage market, with the centerpiece being a new line of mortgage-backed securities. Here's how it would work:
Each security would have two components: a) a security-level, federal government-guaranteed "wrap," which would in turn be backed by b) private, loan-level guarantees from privately owned, government-chartered and regulated mortgage credit guarantor entities.
The government guarantee would be similar to that provided by Ginnie Mae by guaranteeing timely interest and principal payments to bondholders and explicitly carrying the full faith and credit of the U.S. government.
These guarantees would be supported by a federal insurance fund, capitalized by risk-based fees charged on the supported securities (the FDIC-like part of the plan). This government wrap will help provide affordable financing rates.
In supporting their own loan-level guarantees, the MCGEs would rely on their own capital base as well as credit enhancements from originators, issuers and other secondary market entities such as mortgage insurers. Investors in the guaranteed mortgage-backed securities would face no credit risk and would take on only interest rate risk.
It is important to note that while the mortgage-backed securities in this model would be guaranteed by the government, the MCGEs as institutions would not. The corporate debt and equity issued by the MCGEs would be purely private. This creates an important alignment of interests, as the investors in the debt and equity of the MCGEs take the credit risk of the mortgages purchased and securitized by the MCGEs.
As with other firms, investors in MCGE equity and debt would accept the potential risk of failure and loss. For this reason, the MBA proposal recommends regulators charter enough MCGEs to establish a truly competitive secondary market, and to overcome issues associated with "too big to fail."
The MBA's proposal combines the best of both the public and private sectors. It acknowledges that only a government guarantee can attract the depth and breadth of capital necessary for sustainable market liquidity through all economic cycles. However, it relies on private capital, insists on multiple layers of protections for taxpayers and a focus on ensuring a competitive, efficient secondary mortgage market.