While those of us in the mortgage and banking industries were cautioned not to expect too much from the administration’s report to congress – the document released today was underwhelming in all but one respect: the administration has stated clearly that there is absolutely no rationale for continuing the farce of FannieMae and FreddieMac as private companies benefitting from government support – implicit or explicit. For that, we suppose we should be thankful.
In all other respects, the report is best characterised as ham and cheese on white bread with mayo….nourishing insofar as it feeds us a reasonably accurate historical summary of the absence of sanity that took hold of the mortgage finance system over the past 15 year; but uninspiring and timid in its lack of firm support for a set of absolute goals and timelines that will bring the erstwhile practice of business-as-usual to an end. We can only hope that the administration and the independent regulators move swiftly to obtain market and analytical comment and get on with the task at hand.
Our view on what needs to be done can be summarized as follows:
The GSE’s should consist of a merged and non-private Freddie/Fannie agency to be restricted to the insurance of mortgages or RMBS that conform to very tight limits. We do not believe that private markets are large enough to absorb risk on the nearly $7 trillion of mortgages that currently enjoy one form of government guarantee or another.
Contrary to the QRM safe harbor that is anticipated under Dodd-Frank, however, we believe that a reformed system must include private sector capital in the form of BOTH significant borrower down payments, and meaningful risk retention by originators/securitizers.
In theory, risk retention is a credit issue that markets should not need regulated, but as a practical matter we need to confront the following issues or the lack of risk retention by originators/securitizers morphs into a systemic issue:
- Overreliance on third party credit assessments (risk agencies) that do not appropriately factor in the importance of skin in the game (or feel that it can be priced around);
- Repo and other financing supplied by banking institutions and collateralized by securities backed by mortgages without originator risk retention; and
- The magnification of such improperly assessed risks through real and synthetic derivate issuance and trading.
The real devil underlying the recent housing/debt bubble is our bifurcated system of residential property valuation in which only housing units that are rented are valued for their income potential, whilst owner occupied units are valued only on comparable sales and replacement cost. Tying non-rental unit valuation to implied prevailing rent and rent multiples within markets is the best way to prevent future bubbles that arise from unwise debt creation in the private sector.
We only wish that the administration had, in its report this morning, been as resolute as we have been. “Defer no time, delays have dangerous ends.” – Henry VI, Part 1, William Shakespeare