FHFA’s Credit Risk Program and the Future of GSE Legislation in Housing

BPC Action believes that while housing is one of the major drivers of the U.S. economy, current federal housing policy is ill-equipped to respond to the many housing challenges facing the U.S. today. We support reforming our broken housing finance system and creating a healthy, stable, and affordable housing market in order to ensure a strong economy and a globally competitive country.  The following information is from BPC, our 501 (c) (3) affiliate. 

If there is one feature of a reformed housing finance system that has broad bipartisan buy-in, it is that private capital should take the vast majority of mortgage credit risk. Since 2012, Federal Housing Finance Agency (FHFA) leadership has made this a central component of their strategic plans for de-risking government-sponsored entities (GSEs) Fannie Mae and Freddie Mac and reducing taxpayer exposure while they remain in conservatorship. The vehicle for bringing private capital into the mix is commonly referred to as credit risk transfer, or CRT. By year-end 2015, the GSEs had collectively transferred to private investors at least some of the risk on $837 billion of unpaid principal balance to private capital through various forms of CRT. The FHFA has also directed Fannie and Freddie to substantially ramp up their CRT activities in 2016 and beyond.

While the centrality of risk-sharing in the Housing Finance Reform and Taxpayer Protection Act of 2014, commonly known as Johnson-Crapo, was not in dispute, there were continuing disagreements on this subject as the bill was being voted out of committee: How much risk-sharing should be achieved through back-end and front-end structures? Could guarantors with permanent sources of capital and who price credit risk over the full economic cycle coexist with more volatile, cyclically-sensitive, and transaction-based CRT structures (the concern being that capital markets investors would underbid guarantors’ pricing during good economic times and either pull out of the market altogether or charge higher prices when the economy heads south)? It is fair to say these disagreements were a contributing factor in preventing Johnson-Crapo from moving to a Senate floor vote.

CRT has been frequently mentioned in reform proposals as a principal means of putting private capital in front of a catastrophic government guarantee.

Since then, CRT has been frequently mentioned in reform proposals as a principal means of putting private capital in front of a catastrophic government guarantee, turning FHFA into a sophisticated laboratory for the design, testing, and scaling of back-end risk sharing mechanisms. In fact, FHFA’s recent call for stakeholder advice on how to adopt additional front-end credit risk transfer structures is an important development on the path to long-term housing finance reform.

In response to FHFA’s request for comment, researchers from the Urban Institute and Moody’s Analytics recently posted a broad set of recommendations on how FHFA could significantly improve the GSEs’ risk-sharing programs. Their prescription for further developing the CRT market merits close attention because two of the collaborators, Jim Parrott and Mark Zandi, have also co-authored a proposal that is widely expected to become Secretary Hillary Clinton’s opening bid for legislative GSE reform should she win the presidential election. How they think about broadening FHFA’s mix of front- and back-end CRT structures to determine their impacts on consumers and the broader financial system is important. The wide-ranging recommendations in the Urban-Moody’s paper for improving FHFA’s CRT program include developing, piloting, scaling, and evaluating the effects of these additional CRT structures:

  • Lender recourse across lenders of all sizes;
  • Deep cover mortgage insurance;
  • Back-end capital markets transactions by loan-to-value ratios and credit score ranges; and
  • Catastrophic risk transfers.

The one thing that is missing from the proposal is a timeline. How long would it take FHFA to complete this work, which the authors implicitly argue is critical to crafting and finalizing a legislative solution for GSE reform?

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