Reform of Government-Sponsored Enterprises

In evaluating proposals to rebuild the nation’s housing finance system, the federal government should be guided by the following:

• Access to credit and liquidity—the housing finance system should provide sufficient credit for the development and purchase of single-family and multifamily units adequate to meet the housing needs of the nation, including lower-income households. Consistent and adequate liquidity is essential to the availability of quality credit. Achieving this goal requires:
  • a strong network of primary lending facilities;
  • well-functioning and robust secondary markets;
  • careful but creative innovations balanced with the goal of consumer protection; and
  • adequate access to credit for all appropriate forms of housing to meet the needs of all consumers, regardless of income or location.
• Counter cyclicality—measures to ensure consistent access to credit & liquidity. A successful housing finance system should ensure a consistent flow of credit, appropriately priced for market risks, in both good and bad times.
• Risk management and oversight—a vital component of a stable and successful mortgage finance system is ensuring that credit risk is appropriately measured, priced, distributed, and overseen. Regulation of credit risk should be comprehensive and robust, covering all aspects of the mortgage market, including secondary markets. A commitment to improving credit risk oversight will help craft a fairer system that will see fewer homeowners default on their mortgage obligations. Key steps to ensure that this happens are:
  • a level playing field, with robust and comprehensive regulation;
  • strong underwriting standards, which should ultimately result in more careful allocation of credit, not a deprivation of credit to underserved communities; and
  • better risk assessment and capital adequacy, including changes in how the markets assess risk (currently through the rating agencies), as well as how risk-based capital requirements are determined.
• Standardization—standardization provides benefits to consumers and investors, helps ensure the safety and soundness of financial institutions, and improves the transparency and liquidity of housing finance. The benefits of standardization, however, must be balanced against the benefits of innovation and meeting unique needs, especially of underserved borrowers.
• Transparency and accountability—reforms of the housing finance system must be cognizant of aligning incentives that promote accountability and ensure transparency.
• Systemic stability—a reformed housing finance system must be able to lessen the possibility of future shocks through the entire financial system. It is important to ensure that risk is appropriately understood and allocated, so that those holding the ultimate risk can afford to bear it. Better measures of gauging counterparty and systemic risk must be adopted, and consideration must be given to other mechanisms for containing and minimizing risk. Design of a renewed mortgage finance system should also recognize the global nature of today’s financial markets.
• Enhanced consumer protection—to address unequal information in mortgage transactions, the system should have a built-in bias toward the long-term best interests of the borrower. Reforms should not only protect borrowers against bad actors but also set up a system of default options such as “qualified residential mortgages” as defined under the Dodd-Frank Act to ensure better outcomes.
• Equitable and fair access to credit for consumers and communities—the mortgage finance system should be designed to eliminate disparities in the allocation of credit and to ensure that communities that have historically suffered from denials of credit or credit on discriminatory or predatory terms have appropriate access to credit from all parts of the finance system.

To facilitate the transition from conservatorship of the GSEs to a new housing finance system, the following key goals are essential:

• preserving the availability of 30-year fixed-rate, penalty-free, prepayable mortgages at reasonable cost to creditworthy borrowers;
• assuring adequate support for decent, affordable rental housing;
• ensuring equal access to the secondary market for a broad array of financial institutions, including community banks, credit unions, and community development financial institutions, so that communities of all sizes can benefit from securitization; and
• fostering safe, affordable innovations in mortgage products, such as reverse mortgages and residential care options that can meet a wide variety of needs for older people seeking to age in place.

Congress should enact housing finance reform legislation that is guided by the following framework:

• Explicit and limited federal guarantee on mortgage-backed securities (MBS)—any federal guarantee offered in a new housing finance system should be explicit, transparently priced, and limited solely to the principal and interest of MBS products meeting rigorous federal standards.
• Catastrophic insurance fund—a federally run catastrophic insurance fund, similar to the Federal Deposit Insurance Fund, should be established to price and collect premiums that back guarantees on MBS in the event of financial failure. The fund should have the authority to:
  • establish rigorous product and underwriting standards for mortgages placed into guaranteed securities,
  • institute rigorous and transparent securitization standards governing the issuance of MBS, and
  • enforce its rules and regulations.

MBS guarantee institutions—to incentivize the flow of private capital into the secondary market, federally chartered guarantee institutions should be authorized to provide investors in MBS with a guarantee of timely payment of principal and interest on securities that are backed by loans eligible for such support through the catastrophic insurance fund. Guarantee institutions should have features such as the following:

• ownership—a variety of ownership structures should be permitted and should preclude conflicts of interest and misalignment of incentives.
• capital requirements—the federal government should strictly regulate guarantee institutions for capital adequacy and compliance with consumer protection standards. Capital requirements should be significantly higher than those currently required of the GSEs.
• taxpayer liability—in the event a guarantee institution fails, its equity and corporate debt should be liquidated before the catastrophic insurance fund is exposed to any losses.
• use of portfolios—guarantee institutions should be permitted to have portfolios. However, their use should be restricted to financing difficult to securitize loans, such as some multifamily loans and loans designed to test new products. The size of portfolios should be limited by federal rules and their use subject to strict oversight by federal regulators. Any debt issued to finance portfolio lending must be for public purposes and not be covered by a federal guarantee.
• prohibitions on campaign contributions and political activities—as a condition of their federal charter, guarantee institutions should be strictly prohibited from making campaign contributions or engaging in partisan political activities of any type.

Innovation Fund—an innovation fund should be established to provide, on a competitive and shared risk basis, additional credit enhancement and research and development funds for promising mortgage finance products, such as reverse mortgages and residential care options, that could better meet the needs of underserved markets. The Innovation Fund should be financed by a fee on all MBS. This fee should also fund the National Housing Trust Fund and the Capital Magnet Fund, which finances states and community development financial institutions to support affordable rental housing.

Equal access for all financial institutions and communities—guarantee institutions should be required to provide an equitable outlet for the securitization of all loans that meet the standards for the guarantee. They should be required to mirror the primary market in the amount and geography of single-family and moderate-income loans that are securitized and eligible for the federal guarantee.

Affordable rental housing—guarantee institutions should be required to guarantee multifamily loans and to demonstrate that at least 50 percent of the units supported by securitized multifamily loans during the preceding year were offered at rents that were affordable to households at 80 percent of the area median income or less.

Special housing needs—guarantee institutions should be required to provide guarantees to ensure funding for areas of specific concern (identified annually such as rural housing, small rental properties, and shortages created by special market conditions.