Exclusive: Josh Rosner and Glen Corso on why it's

time for true GSE reform

Industry insiders weigh in on the future of Fannie Mae and Freddie Mac

Glen Corso and Josh Rosner

December 2, 2015

Seven years after the mortgage crisis, and the placing of Fannie Mae and Freddie Mac into conservatorship
under the independent federal agency, the Federal Housing Finance Agency, the Obama administration still
must address the issues that are of great importance to consumers seeking to buy a home, lenders who seek to
finance those purchases and the future viability of the U.S. mortgage market.

The independent FHFA has failed to advance the policies required by the Housing and Recovery Act of 2008
and the administration continues to stand pat, waiting for Congress to act legislatively. Treasury Secretary
Lew and Michael Stegman, Senior Housing Policy Advisor to President Obama recently articulated this
approach.

While the regulatory and safety and soundness authorities included in HERA meant the GSEs may not have
actually required government support in the first place, these authorities have not been implemented due to
the government control of the companies.

As a result, rather than holding more than the inadequate amounts of capital they held before the crisis, the
GSEs have no capital at all. Their earnings are sent to the Treasury rather than retained to build capital
and the GSEs are forced to rely on government support.

As Washington wrings its hands over the Federal Housing Administrations 2% reserve number (it is
backstopped by the federal government), Fannie Maes reserve capital is .06%. Thats not a typo: the FHA
has 33 times the reserves of Fannie Mae, a $3 trillion company.

In the face of these realities, Washington is deadlocked and has shown little interest in meaningful legislative
reform of the GSEs, even though they are the backbone of the mortgage finance system and chartered
to ensure lenders have the financial and market liquidity to provide mortgage loans in both good times and
bad.

A growing chorus of small lenders, affordable housing advocates, civil rights groups and capital market
participants have asked that the GSEs regulator and conservator exercise the authorities provided him under
HERA, and permit the GSEs to build adequate levels of capital so that they do not pose a risk to the public.

These same groups have also asked that once the conservator is satisfied the GSEs are adequately capitalized,
the GSEs regulator then begin the process of releasing the GSEs as required by HERA from direct
government control.
Instead, and in violation of HERAs clear congressional intent, the independent regulator has failed to do so
and appears not to be acting independently as required. Rather, he is taking directions
from Administration officials who appear committed to gifting the GSEs business to our largest banks.

We suggest policymakers read the Washington Post article from January 2015 (The American Dream Shatters
in Prince Georges County, Jan. 24, 2015) on how non-GSE loan programs bled the homeowners in Prince
George's County from their home equity and savings in the bubble years.

It's a heartbreaking story of what will happen again if Wall Street and big banks get their way.

Under HERA, the FHFA has significant powers that would ensure the GSEs function more safely regardless
of legislative reform. These include but are not limited to the ability to require that they be obligated to
fund only well-underwritten and plain vanilla loans, and that they have only negligible exposures to
the portfolios that allowed them to leverage their balance sheets.

The regulator also has the ability to prevent them from engaging in pricing their insurance in a manner that
favors large lenders as before. Most importantly, unlike the regulatory authorities that existed between 1992
and the crisis, the Act provides the regulator with the clear authority to place the GSEs safety and soundness
ahead of public policy goals while ensuring that the GSEs expand the commitment to affordable housing (but
not where these goals imperil the safety of either borrowers or the GSEs.)

In other words, the regulator now is much stronger compared to what existed before 2008.

Additionally, under HERA, the Federal Government could continue to provide a line of credit from the
Treasury to the GSEs, thus providing an explicit Treasury backstop. In 2008, the GSEs, the Conservator and
Treasury had authorized and agreed that the government could levy a periodic commitment fee which, set at a
proper level, would effectively pay for the existing federal backing without Congressional involvement. This
authority removes the implicit GSE backing that bothers many.

One concern articulated by those opposed to recapitalizing and releasing the GSEs is that once they are
free of conservatorship, the companies will once again be forced to balance their public purposes against
their shareholders interests. This concern ignores all the other authorities granted to the FHFA in
HERA that would prevent nearly all of the activities that imperiled the GSEs in the first place.

If FHFA instituted all of the changes required by HERA, it would become politically easy to move the narrow
and limited legislation necessary to require that the GSEs pay for their very limited but explicit government
catastrophic insurance policy that would allow the GSEs to continue to support the To Be
Announced Market.

That line of credit would stand behind monumentally significant levels of capital, ensuring that the GSEs can
absorb losses and that they will transfer much of the risks back into the private market and away
from the taxpayer. Moreover, in crafting that narrow legislation, Congress would be in a position to
legislate that the GSEs become like other such enterprises (water, gas, sewer and electric utilities). As
such, the GSEs would become dividend-focused granny stocks with a fixed rate of return cap, a public
utility commission and an investor base that is stable and long-term focused.

A second concern of opponents is that the recapitalization and release of the GSEs would create two new
systemically important financial institutions with the result of potentially higher mortgage costs and less
product flexibility. The reality is that the companies in or out of conservatorship are systemically
important, highlighting the need to reduce the governments exposure while ensuring their safety and
soundness.
These opponents also ignore the reality that the underpricing of mortgage risks is precisely what caused the
crisis. With its expanded authority under HERA, the regulator today is in a position to set pricing policy to
create long-term safe lending, thus providing lenders with the liquidity necessary to allow the lowest possible
level of increases in pricing while ensuring the safety and soundness of both borrowers and the GSEs
securities, and fully supporting underserved borrowers.

Pretending that a fully private market can, or would, be interested in and able to adhere to those goals, is
unrealistic.

Endless conservatorship of the worlds second-largest securities market has so many inefficiencies that
they are impossible to list briefly. To quote one critic Investors today see the Treasury capital pledge and
take comfort from this dont ask, dont tell form of explicit guarantee.

Is this really a healthy, sustainable or efficient form of capitalism? Is it even capitalism?

This distorted and convoluted ownership structure has led to further distortions including efforts by Congress
to siphon the insurance premium fees the GSEs charge lenders for the risks they are accepting and has sought
to use them to fund sundry other federal priorities.

If this continues, the next generation of homebuyers younger, more ethnically diverse, and hungry for
mobility will pay extra fees for other federal programs, certainly a generational pay it backward (to
wealthier Baby Boomers).

At a time when Baby Boomers have record wealth and cheap mortgages, and young generations already
struggle to make their way with student debt, this cant be a desired outcome.

Importantly, but seemingly ignored by the Administration and some in Congress, small lenders remain fearful
of the power of the large bank lobby, and know that until the GSEs are released, this power could find a way
to move the mortgage market away from small lenders to their larger competitors.

As even some opponents of recapitalization and release of the GSEs acknowledge, the biggest banks are
already succeeding with the help of big-bank-funded think tanks in pushing to expand the government
backstop from a potential limited catastrophic risk insurance policy behind well-capitalized GSEs to a
government backstop behind all conforming mortgage backed securities.

These too-big-to-fail banks are seeking access to a common securitization platform that the GSEs have been
required to build and fund and, if allowed, would be in a position to turn the smaller lenders into their own
third-party originators so that they could recapture their pre-crisis dominant position in the mortgage market.

The too-big-to-fail banks are also seeking the ability to use risk transfer products as a way to starve the
GSEs of insurance premiums so that they can receive highly leveraged returns while leaving the GSEs with
the catastrophic risk. There is not a capital markets expert who would not acknowledge that precisely in those
periods in which private loss-absorbing funding would be necessary (in an economic downturn), that
funding would vanish.

We saw this liquidity run during the crisis and there is no basis to expect next time to be different. As a
result, rather than having well-capitalized secondary market liquidity providers standing by to lend (as the
GSEs did in prior crises) the government would once again be on the hook for the risks borne by private
market participants.

If the goal of Dodd Frank were to reduce the systemic risk and interconnectedness of these too-big-to-fail
banks then the approach that many on the Hill and the largest lenders are pushing would undermine those
efforts.

In finance, uncertainty has a real cost, and as the Urban Institute has noted, the general uncertainty around
conservatorship has caused credit tightening beyond what is needed for safety and soundness. Why?
Companies in conservatorship will always sub-optimize as executives keep their heads down to avoid
running afoul of regulators, Congress, and the Treasury master upon whom they have to rely for the capital
they have not been allowed to retain.

The result? Record high FICO scores at both GSEs, and lenders telling us that only pristine product
can move. Fannie and Freddie have moderated formerly onerous put-back requirements, but the slow pace of
these reforms have caused lenders ones that did not go whole-hog for the distortionary loans products in
the 2004-07 time frame, to have very tight overlays today.

Running the GSEs as recapitalized utilities, coupled with the authorities of HERA, would restore the balance
not too hot as before, but not too cold as now that would allow credit decisions to flow in a safe and
sound manner. This approach would also reduce the commingling of the utility-like goals of the secondary
market with the growth and high-profit goals of primary market lenders.

After all, it was this commingling of functions that led to the GSEs mission creep, the race to zero between
primary market lenders and the GSEs, and their dance toward the precipice. There is no reason to expect a
different outcome if primary market players are handed the controls of the secondary market.

With a utility approach, the GSEs would have rigorous oversight, but not the stifling conservatorships where
even small decisions have to go through multiple layers of reviews and bureaucracy. This would absolutely
help first-time buyers and modest-income Americans who pay their bills and want a carefully underwritten
mortgage granted in a reasonable amount of time.

And ending the conservatorships, combined with significantly higher capital than pre-crisis, would protect
the affordable housing trust fund money, currently at risk because a GSE with no capital may need to take a
new Treasury draw, thereby suspending trust fund payments.

Author Bethany MacLean said recently that Fannie and Freddie are the last major institutions to remain in
post-crisis uncertainty. One principle nearly everyone agrees upon is this: no one wanted or favors endless
GSE conservatorships.

If it were such a great idea, the government would have placed half the U.S. banking system into endless
conservatorship during and after the crisis. It didn't.

Since the crisis of 2008, the nations wealthiest people those with large savings accounts, stocks, and
bonds have been able to move on with their economic lives, making decisions and providing for their
families and communities.

Its time for those seeking the first rung of the economic ladder to be allowed to do the same.
Glen Corso is Executive Director of the Community Mortgage Lenders of America, a trade association based
in Washington, DC. The CMLAs members are mid-sized and small, community-based residential mortgage
lenders. Glens work for the CMLA involves lobbying, regulatory analysis and communications.

Josh Rosner is co-author of the New York Times Bestseller "Reckless Endangerment "How Outsized
Ambition, Greed, and Corruption Led to Economic Armageddon", and Managing Director at independent
research consultancy Graham Fisher & Co. He advises regulators, policy-makers and institutional investors
on banking and mortgage finance.