The Mayfield Bridge in Fredericksburg, Virginia, was built to span the Rappahannock River and connect Stafford County and the City of Fredericksburg; the bridge would ultimately provide an alternative to driving through the City of Fredericksburg and crossing the Chatham Bridge to get to Stafford County. When the Mayfield Bridge was completed, however, it went nowhere; hence, it was dubbed by locals as the “Bridge to Nowhere”. The State Route 3 bypass connecting to the Mayfield Bridge was eventually completed, and the bridge fulfilled its purpose; but not before its nickname stuck. As it stands today, its sister bridge, the 78-year old Chatham Bridge, is in dire need of repair and will be shut down for 16 months. The history of these two bridges draws a parallel to the history of housing finance reform in our country.
As you may have heard, read, seen or received via Tweet, LinkedIn update, text message, or email, the U.S. Department of the Treasury published its Housing Reform Plan (the Plan), on September 5, 2019, outlining, in broad strokes, the future for Fannie Mae and Freddie Mac (the GSEs), which, after 11 years (almost to the day), remain in conservatorship under the stewardship of the Federal Housing Finance Agency (FHFA).
The push for housing finance reform is not new, nor is it something that grew out of the Great Recession. Each Administration and Congress has been trying to exert greater control over Fannie Mae and Freddie Mac (almost) since the moment both GSEs were privatized, which for Fannie Mae was in 1970, and for Freddie Mac was in 1989. Housing finance reform, both pre- and post-Great Recession, has been the subject of volumes of research, white papers, books, studies, reports, discussions, Congressional testimony, proposed and enacted legislation, and proposed and final regulations. Although much has been said and written about housing finance reform, particularly in the past few years, the Plan is our first glimpse into this Administration’s proposal to end the conservatorship of the GSEs (including the recapitalization of the GSEs), preserve the fixed-rate 30-year mortgage, foster growth in affordable housing, promote the participation of private capital, reduce the footprint of the GSEs (with respect to the single family market and the multifamily market), clearly define an explicit, paid-for-guarantee backed by the full faith and credit of the Federal Government, reduce taxpayers’ exposure to losses, and establish capital standards for the GSEs more along the lines of what the banks have to retain.
How does housing finance reform relate to the bridges in Fredericksburg?
The GSEs are represented by the Chatham Bridge, which was completed in 1941. Fannie Mae was established in 1938; Freddie Mac was established in 1970. The GSEs have served the public well over their existence by purchasing trillions of dollars in single family debt (and billions of multifamily debt) over their combined 130 years of existence and providing liquidity to the housing market. While the Chatham Bridge may not have carried trillions of cars and pedestrians over the Rappahannock River over the past 78 years, the people of Fredericksburg, and the surrounding region, would argue that the bridge has served the people well. It is now time to fix the Chatham Bridge and to fix the GSEs.
Housing finance reform is represented by the Bridge to Nowhere. After completion, the Bridge to Nowhere went effectively nowhere, hence its nickname. However, that was relatively short-lived, and the bridge eventually fulfilled its purpose – to connect the bypass road to the main highway. The same can be said of housing finance reform and the GSEs pre-conservatorship: there were lots of plans and ideas, but reform went nowhere. During the 2008 financial crisis, Congress passed the Housing and Economic Recovery Act of 2008 (HERA), which, among other things, established the FHFA, an independent regulator funded through industry assessments. HERA also gave FHFA the authority to place a GSE into conservatorship or receivership, and, on September 6, 2008, FHFA placed both GSEs into conservatorship. The following day, Treasury exercised its authority under HERA to enter into the Senior Preferred Stock Purchase Agreements (PSPA) through which Treasury agreed to advance funds to each GSE to insure that each GSE’s net worth will never go below zero. In exchange, Treasury received $1 billion of senior preferred stock in each GSE, a dollar-for-dollar increase in the preferred stock each time a GSE drew on the capital commitment, warrants for purchase of common stock of each GSE representing 79.9% of the common stock of each GSE, and senior preferred stock dividend accruals at 10% per year (the dividends are paid quarterly). The construct of each PSPA has been amended three times, twice to increase Treasury’s funding commitments, and a third time, in 2012, to replace the quarterly dividend with a variable dividend equal to each GSE’s net cash flow, after allowance for a capital reserve – the infamous “net worth sweep.”1
During the first few years of conservatorship, FHFA’s focus was geared more towards triage: reduce the GSEs’ losses, manage their operational and credit risk, and stabilize the housing market. Since 2012, FHFA has taken a more strategic approach to the GSEs. FHFA’s initial approach focused on contracting the GSEs and promoting private capital participation in the secondary mortgage market. The net worth sweep would, in addition to paying Treasury back for the money it had advanced to the GSEs2, make it difficult for the GSEs to be able to build capital. In 2014, FHFA changed tack and moved away from its goal of contracting the GSEs while continuing some of the initiatives it had undertaken during this time: better aligning the GSEs’ guarantee fees with what a private institution would charge3, establishing programs for credit risk transfers (CRTs), and building a common securitization platform. Some would say that these initiatives have served as some of the “footings” for our housing reform bridge.
Are we there yet?
No, we are not there yet.
The Plan delivered on September 5, 2019, was delivered in response to a Presidential Memorandum issued on March 27, 2019, directing the Secretary of the Treasury to develop a plan for administrative and legislative reforms to achieve the following housing reform goals:
- ending the conservatorship of the GSEs;
- facilitating competition in the housing finance market;
- establishing regulations for the GSEs that safeguard their safety and soundness and minimize the risks they pose to the financial stability of the United States; and
- providing that the Federal Government is property compensated for any explicit or implicit support it provides to the GSEs or the secondary housing finance market.
The Plan outlines legislative and administrative reforms (some with more specificity than others) to be undertaken to achieve the housing reform goals outlined in the Presidential Memorandum. Overall, the Plan lays out three objectives:
- defining the role of the Federal Government with respect to the housing finance market;
- protecting taxpayers against future bailouts; and
- promoting competition in the housing finance market.
Each objective is further broken down into specific goals, and for each goal, the Plan outlines legislative or administrative action to be undertaken. With respect to the objective of defining a limited role for the Federal Government, the Plan lays out the goals of (1) clarifying existing government support (authorizing an explicit paid-for guarantee by Ginnie Mae of qualifying MBS – single and multifamily4), (2) authorizing FHFA to set and adjust the fees for government guarantees of qualifying MBS, (3) restricting GSE business to securitizing government-guaranteed MBS only, (4) limiting each GSE’s multifamily business, (5) replacing the GSE’s statutory affordable housing goals with more tailored guidelines which will provide better support for first-time homebuyers, low and moderate income homebuyers, and rural and other historically underserved borrowers, and (6) ending the conservatorship of the GSEs.
With respect to the objective of protecting the taxpayers against future bailouts, the Plan identifies the goals of (1) prescribing capital and liquidity requirements for the GSEs more in line with the capital requirements for other financial institutions (and the repeal of any statutory provisions which restrict FHFA’s ability to prescribe these new capital requirements), (2) supporting the GSEs’ credit risk transfer initiatives, (3) ensuring that each GSE maintains adequate amounts of convertible debt or other similar loss-absorbing instruments sufficient so that there is adequate total loss-absorbing capacity to facilitate resolution, (4) limiting each GSE’s investment in mortgage-related assets or other investments except to the extent necessary to engage in their core business of securitizing government-guaranteed MBS, and (5) ending the QM patch5.
Lastly, with respect to promoting competition in the housing finance market, the Plan lays out the goals of (1) leveling the playing field for the GSEs and other participants in the housing finance system, (2) having Congress authorize FHFA to charter competitors to the GSEs (the new guarantors) and direct the FHFA to re-charter the GSEs on the same charter available to the new guarantors, and (3) requiring the re-chartered GSEs and the new guarantors to operate in a manner which would increase accessibility to the capital markets for all originating lenders.
Where are we then?
While further discussion of each objective and goal in more detail is beyond the scope of this article, we note that much has happened since the Plan was issued on September 5th. On September 6th, the U.S. Court of Appeals for the Fifth Circuit issued its opinion on Collins (see footnote 1) holding that the net worth sweep exceeded FHFA’s authority as a conservator under HERA, and that it was unconstitutional for Congress to make the head of the FHFA removable by the president only for cause.
Hot on the heels of the Plan and the decision on Collins, the Senate Banking Committee conducted a hearing on September 10th with Treasury Secretary Mnuchin, HUD Secretary Carson, and FHFA Director Calabria as the witnesses. In his testimony, Secretary Mnuchin stated that, although the Administration would prefer to work with Congress on comprehensive housing reform, the Administration would take administrative and regulatory action, to the maximum extent possible, to begin transitioning the GSEs out of conservatorship and to being putting the Plan into effect. Based on how the hearing went (largely along party lines), there is some question as to whether Congress will act before the 2020 elections.
To cap off an otherwise already busy time for housing finance reform, FHFA announced on Friday, September 13th, that the GSEs will be subject to revised and restructured caps for their multifamily business. Specifically, FHFA did away with the volume cap exclusions (such as affordable housing and green initiatives) and replaced them with an overall volume cap of $100 billion for each GSE for Q4 2019 through Q4 2020 (i.e., five quarters), effectively suggesting a $80 billion annual cap for each GSE. In addition, each GSE must dedicate at least 37.5% of its multifamily business to “mission-driven affordable housing”.
FHFA will consider the following categories as “mission-driven affordable housing”: (1) loans on targeted affordable housing properties (properties subject to a regulatory agreement, low income housing tax credits, zoning, tax abatement or other mechanism restricting a portion of the units for occupancy by tenants with limited incomes, properties subject to a Section 8 Housing Assistance Payment contract, or properties where a public housing authority or other non-profit company is the borrower and the property is subject to a regulatory agreement or other restriction); (2) loans on other affordable units based on the percentage of units with affordable, unsubsidized/market rents (adjusted for standard markets, cost-burdened, very cost-burdened, or extremely cost-burdened markets); (3) loans on properties located in rural areas based on the percentage of units affordable at 80% of area median income (AMI) or below; (4) loans on small multifamily properties (5 to 50 units) based on the percentage of affordable units (adjusted for standard markets, cost-burdened, very cost-burdened, or extremely cost-burdened markets); (5) loans on manufactured housing rental communities; and (6) loans on seniors housing based on the percentage of units affordable at 80% of AMI or below.
We have heard of housing finance reform before and how it is imminent. While some argue that legislative action may not occur until after the 2020 elections, administrative action by FHFA is underway. Treasury Secretary Mnuchin announced on September 12th in an interview with CNBC’s Squawk Box that the Administration is “actively negotiating an amendment [to the PSPAs] to [end the net worth sweep] by the end of the month.” In an interview on Bloomberg’s “Bloomberg Markets” on September 16th, Director Calabria confirmed that FHFA is in active negotiations with Treasury to amend the PSPAs establishing capital requirements for the GSEs and ending the net worth sweep. Director Calabria stipulated that the forthcoming amendment to the PSPAs will establish capital “mile markers” that each GSE will be responsible for hitting on their road to recapitalization. Ending the net worth sweep requires only administrative action, i.e., the Administration can accomplish this without Congressional action.
The housing finance reform bridge has been under construction for several years under different sets of construction plans. The Plan is the latest set of such plans and builds upon the footings that have been laid down since the Great Recession (with some changes). While the Administration may undertake some of the construction work on the foundation, the substructure and the superstructure will require Congressional action.