This article provides a brief summary of the key provisions of a new bi-partisan Senate bill, based on the Housing Finance Reform and Taxpayer Protection Act of 2013, as well as a brief discussion of a new House of Representatives bill, the Housing Opportunities Move the Economy Forward Act of 2014, both of which are intended to reform the U.S. housing finance market.
On March 16, the Senate Committee on Banking, Housing and Urban Affairs (the “Committee”) released the text of a proposed housing finance reform bill, known as the “Housing Finance Reform and Taxpayer Protection Act of 2014” (the “Reform Bill” or “Bill”).1 Sponsored by Committee Chairman Tim Johnson and Ranking Member Mike Crapo, the Reform Bill follows on the heels of a similar bi-partisan bill introduced last year by Senators Bob Corker and Mark Warner, both members of the Committee, entitled “Housing Finance Reform and Taxpayer Protection Act of 2013” (the “Corker-Warner Bill”). The Reform Bill is broadly similar to the Corker-Warner Bill and, like that earlier proposal, would replace Fannie Mae and Freddie Mac (the “GSEs”) with a new independent government agency called the Federal Mortgage Insurance Corporation (“FMIC”).2 If enacted, the Bill would wind down the GSEs over a period of five years and replace the current housing finance structure with one centered on the FMIC.
Like the Corker-Warner Bill, the Reform Bill would create a general structure for a new approach to the mortgage finance market and lay out a path for transition, but the establishment of many of the finer details of the FMIC’s operation would be left to later regulatory action. Among the Reform Bill’s key points are the following:
- Private investors in single-family covered securities would be required to hold a first loss position adequate to cover losses incurred in a period of economic stress.
- The FMIC, in exchange for a fee, would insure the payment of principal and interest on covered securities provided that private investors had taken a first loss position in accordance with the provisions of the Reform Bill.
- The FMIC would establish a Securitization Platform and develop standard uniform securitization agreements and standard contractual terms for securities issued through the Securitization Platform.
- The FMIC would be responsible for promulgating standards for the approval and supervision of guarantors, aggregators and servicers, among other participants in its Securitization Platform.
- Investors that have taken the first loss position in a covered security or otherwise invested in a covered security insured under the Reform Bill shall have immunity from civil liability under Federal and State law with respect to whether or not loans that collateralize a covered security have complied with the requirements of the Reform Bill.
- The FMIC would work to harmonize its standards with those of other government agencies such as the Consumer Financial Protection Bureau.
- The FHFA would transition into an office within the FMIC and the GSEs would be wound down.
This OnPoint provides a brief summary of some of the key provisions of the Reform Bill.
Establishment of the FMIC
If enacted, the Reform Bill would establish a new, independent government agency, the FMIC, six months after the enactment of the Bill (the “Agency Transfer Date”).3 The FMIC would be governed by a five-member Board of Directors, not more than three of whom could be from the same political party. One of the five members would be designated by the President to serve as the Chairperson.4 Once formed, the FMIC would establish a nine-member Advisory Committee responsible for advising both the Board of Directors and the Office of Consumer and Market Access on developments in the primary and secondary mortgage markets.5
The FMIC would also establish a number of specific offices within the agency, each with its own mandate. These would include Offices of Underwriting, Securitization, Federal Home Loan Bank Supervision, Consumer and Market Access and Multifamily Housing.6
Winding Down the GSEs
The Reform Bill lays out a strategy for a transition away from the GSEs. On the Agency Transfer Date, the Federal Housing Finance Agency (the “FHFA”), which currently regulates the GSEs, would become, in its entirety, an independent office within the FMIC. It would continue to function as it does now and its Director would serve as an interim Chairperson of FMIC.7
By the Agency Transfer Date, each GSE would be required to develop a plan to establish a multifamily subsidiary within one year of the enactment of the Reform Bill.8 All functions and employees necessary for the support, maintenance and operation of the multifamily business of the GSEs would then be transferred to the multifamily subsidiary under the FMIC.
Within three months following the Agency Transfer Date, each GSE would also be required to develop a plan for the transition to the new housing finance system.9 These plans would include a full description and valuation of the assets, liabilities and contractual obligations of the GSE. The FMIC would then conduct a valuation study of the GSEs’ business segments to determine what could be sold for value.
After the date on which the Board of Directors of the FMIC certified that the FMIC was able to undertake the duties specified in the Reform Bill the GSEs would be prohibited from engaging in new business. The GSEs would continue to exist until the date on which their guarantee obligations were fully extinguished, at which point their respective charters would be revoked.
Risk Sharing Mechanisms and First-Loss Provisions
The FMIC would be responsible for developing standards for the consideration and approval of credit risk sharing mechanisms.10 A key provision of these standards would require that private investors in single-family covered securities take a first loss position adequate to cover losses incurred in a period of economic stress.11 At minimum, such private investors would be required to take a first loss position that is adequate to cover losses that might be incurred in a period of economic stress, including national and regional home price declines, such as those observed during moderate to severe recession in the United States and equal to not less than 10% of the face value of the relevant securities at the time of issuance. In considering additional risk sharing mechanisms, the FMIC would examine whether they would impair the operation and liquidity of the forward market for single-family mortgage loans and single-family covered securities.
The FMIC would also have the authority to review any mechanisms put into place after the establishment of its standards and suspend its approval if it found the mechanisms to be ineffective or to adversely affect the forward market. Such a suspension would not, however, be retroactive.
In addition, the FMIC would be required to establish standards for the minimum level of collateral diversification in issued securities.
The Government Guarantee
The FMIC would insure the payment of principal and interest on covered securities provided that the private investors either took a first loss position as required by the Reform Bill or an approved guarantor provided a guarantee.12 The terms and conditions for the provision of this insurance are not laid out in the Reform Bill but would be established by later regulation. In order to facilitate this government guarantee, the Bill would establish a Mortgage Insurance Fund (the “MIF”) funded by a fee charged for securities.
The MIF would step in if a payment default on a covered security exceeds the first loss position of the private investor or, in the case of a guarantor, if the guarantor becomes insolvent, or if the servicer or guarantor fails to transfer sufficient funds for the required payment.
At the outset, the target reserve ratio of the MIF would be 0.75%.13 This target reserve ratio would increase to 1.25% of the sum of the outstanding principal balance of covered securities within five years, and to 2.50% of the sum of the outstanding principal balance of covered securities within 10 years and thereafter.14
The Approval and Supervision of Securitization Program Participants
The FMIC would be required to develop, adopt and publish standards for the approval, by the FMIC, of participants in its securitization program, including guarantors, aggregators, and servicers.15 These standards would cover areas such as the financial history of the participant, general character and fitness of the participant, risk presented by the participant and requirements that the participant maintain certain capital levels. The FMIC would also have the power to suspend or revoke its approval of participants.
Small Lender Mutuals
The FMIC would establish an entity known as the “Small Lender Mutual” and set standards for the approval of other small lender mutuals. The purpose of the small lender mutuals would be to enable small lenders, as defined within the Reform Bill, an opportunity to participate in the securitization market where they would otherwise be unable to do so.16
The Securitization Platform
Within one and one half years of the enactment of the Reform Bill, the FMIC would establish a Securitization Platform in the form of a non-profit corporation or other cooperative entity.17 The Securitization Platform would be regulated by the FMIC and would purchase and receive eligible and non-eligible mortgage loans or securities collateralized by such loans and issue standardized covered securities insured by the FMIC and non-covered securities not insured by the FMIC.
The Securitization Platform would also develop standard uniform securitization agreements for all covered securities. These agreements would include, but not be limited to, terms for pooling and servicing, loss mitigation procedures, representations and warranties, indemnification and the duties of trustees. In addition, the Securitization Platform would establish a set of contractual terms and optional uniform securitization agreements for non-covered securities issued through the Securitization Platform.18
Under the Reform Bill, investors that take a first loss position in a covered security or are invested in a covered security insured by the MIF are protected from liability in suits based on claims that the underwriting standards or representations and warranties of the underlying loans were not satisfied or that the terms established by the Securitization Platform were not satisfied. This provision protects investors from civil liability under both Federal and State law.19
The affordable housing mandates currently in place for the GSEs would not be retained under the FMIC. The Reform Bill does, however, make some provisions for affordable housing.20
The FMIC would collect fees, averaging 10 basis points for each dollar of outstanding principal of all eligible mortgages that collateralized covered securities insured under the Reform Bill. These fees would support funds designed to provide market-based incentives encouraging guarantors and aggregators to serve underserved market segments. The specific fees charged to participants could vary based on the assessed performance of those parties in serving such underserved market segments relative to their peers.
The fees would be allocated as follows: 75% to the Housing Trust Fund, administered by the Secretary of Housing and Urban Development, 15% to the Capital Magnet Fund, administered by the Secretary of the Treasury, and 10% to the Market Access Fund (the “MAF”). The MAF would be a new fund administered by the Office of Consumer and Market Access under the FMIC.21 Under the Reform Bill, the MAF could be used to fund grants for research, credit support, and housing counseling.
Analysts state that the first-loss provisions and the additional fees for holders of securities could result in higher mortgage rates or tougher underwriting standards. Lenders would likely impose higher credit standards if required to take on risk at the level proposed by the Reform Bill. The combination of stricter underwriting standards and the absence of a mandate that a percentage of mortgages go to lower- and middle-income families could reduce home ownership rates.22
On Thursday, March 27, 2014, House Financial Services Committee (“House Committee”) Ranking Member Maxine Waters issued proposed new legislation23 entitled: “The Housing Opportunities Move the Economy (HOME) Forward Act of 2014” (the “HOME Forward Act”).24
This proposal mimics legislation that has already been proposed by the Senate with regard to the new regulatory and operating structure that would replace Fannie and Freddie within 5 years.
With regard to the liquidation of Fannie and Freddie, the HOME Forward Act would establish a waterfall for the disbursement of the earnings (to be determined by the FHFA and the Secretary of the Treasury):
- Senior Preferred Shares of Treasury
- A 10% rate of return on those Senior Preferred Shares
- Reserves necessary to pay for the administration of the wind down
- Deferred contributions to the Housing Trust Fund and the Capital Magnet Fund
- Purchase of outstanding preferred shares
- Purchase of outstanding common stock for which warrants held by Treasury are treated as common stock
In addition, the HOME Forward Act would provide the Treasury with authority to sell assets of Fannie Mae and Freddie Mac directly or through other means, such as through a holding company.
Generally, the legislation would:
- Establish the Mortgage Securities Coop (the “MSC”) to issue government-guaranteed securities: a. The MSC would be a cooperative, governed on a one-member, one-vote basis, and capitalized by lenders based on mortgage volume. b. It would hold a first-loss position in front of the catastrophic government guarantee fund—the Mortgage Insurance Fund (“MIF”)—capitalized by a user fee for eligible single-family mortgages.
- Maximize transparency and standardization through uniform pooling and servicing agreements, as well as the creation of new databases to facilitate access to mortgage data.
- Maintain the 30-year, fixed rate mortgage.
- Create the National Mortgage Finance Administration (the “NMFA”), which would oversee the MIF and have authority over underwriting standards, as well as oversight responsibilities over third-party vendors and counterparties to the MSC.
- Provide a “cash window” for small financial institutions, which would aggregate loans from the smallest lenders into multi-lender securities, and work out troubled loans.
- Allow small financial institutions to be represented in the governance of the MSC.
- Authorize the NMFA to establish prudent underwriting standards, adequate capital levels for the MSC, and first-loss credit risk sharing on mortgages.
- Provide an explicit Treasury guarantee for all outstanding enterprise obligations.
- Fund the Housing Trust and the Capital Magnet Funds created under the Housing and Economic Recovery Act of 2008 out of the distribution of funds from the liquidation of Fannie Mae and Freddie Mac.
- Create a new Market Access Fund to support innovation in housing and housing finance.
The future of the Reform Bill remains uncertain. The Committee plans to mark up the Bill on April 29, 2014. Although the Committee is expected to approve the Reform Bill, its margin of success remains uncertain. The upcoming mid-term elections add to the uncertainty over the fate of the Bill.
Swift approval by a strong majority of the Committee with broad bi-partisan support could help to give the Reform Bill, which was drafted with input from the Obama Administration but has yet to gain the support of Senate Democratic leaders, momentum when it reaches the Senate floor.25
The HOME Forward Act also faces an uncertain future in the Republican-controlled House of Representatives.