WASHINGTON — A former top regulator of Fannie Mae and Freddie Mac wants to abandon the development of the common securitization platform and use the existing Ginnie Mae platform to issue government-guaranteed mortgage-backed securities.
Edward DeMarco, a former director of the Federal Housing Finance Agency, argues in a new paper that utilizing Ginnie would make for a smoother transition to a new system.
"We believe that using Ginnie Mae's platform and world-recognized nameplate as a U.S. government backstop guarantor of MBS, but with private capital upfront, provides an easy transition" to a reformed secondary market, he said.
Under the plan, Ginnie would still securitize Federal Housing Administration, Department of Veterans Affairs and Rural Housing Service guaranteed loans in addition to those of the government-sponsored enterprises.
The plan, from DeMarco and Michael Bright, director of the Milken Institute's Center for Financial Markets, would encourage private firms to put capital upfront via credit risk transfers. Fannie and Freddie have already experimented with such transfers, which many observers see as a critical step toward a new housing finance system.
"This structure would replace the failed duopolistic GSE system with one of competitive private insurers, a vibrant market for mortgage credit risk, ownership structures that require lenders to have some skin in the game, and appropriate government standard-setting and oversight to ensure a deep and liquid MBS market," according to the paper, which was issued last week.
The plan envisions FHFA as the overseer of the new secondary market structure while Ginnie would be moved out of the Department of Housing and Urban Development and re-established as a separate government corporation with authority over its budget, hiring and compensation.
David Stevens, the president and chief executive of the Mortgage Bankers Association, said he sees some "interesting similarities" between the Milken plan and the GSE reform proposal advanced by Gene Sperling, former director of the National Economic Council; economist Mark Zandi, Barry Zigas of the Consumer Federation of America, mortgage securitization pioneer Lewis Ranieri and Urban Institute senior fellow Jim Parrott.
"The De Marco-Bright plan builds on the government infrastructure by utilizing Ginnie Mae, while the Parrott-Sperling plan would build a new government-backed corporation by combining Fannie Mae and Freddie Mac," Stevens said.
Both proposals call for "first-loss risk sharing and preserve the cash window," Stevens said, so small lenders can continue to sell their loans for cash.
"It clearly reflects there is some serious thinking around resolving the GSE conservatorships. I think it is good timing with the new Congress coming in next year and new White House. It really broadens the debate," Stevens said in an interview.
Yet the DeMarco-Bright plan would eliminate the common securitization platform, while the Parrott, Zigas and Ranieri plan would not.
Under the DeMarco-Bright plan, Fannie and Freddie would be reconstituted as lender-owned mutual. Lenders would also be required to have "skin in the game" and support a mortgage insurance fund.
"By transforming Fannie and Freddie from GSEs into mutually owned and operated insurers, lenders that are familiar with selling loans to Fannie and Freddie will have the choice to continue to do so," the paper says. "But to align incentives properly, these lenders will become the owners of the mutual. Moreover, the charters would not be exclusive. Lenders could be members at either, both, or neither mutual."
The paper notes that the Federal Home Loan Banks are mutual, with members able to purchase shares based on the advances they borrow.
When asked about the DeMarco-Bright paper, Parrott said, "It's another sign that the discussion has usefully shifted to how best to move what has worked well in the system onto firmer ground, rather than starting from scratch."
The different vision by Sperling, Parrott and others, meanwhile, would merge Fannie and Freddie into a single government corporation.
Parrott and his colleagues issued their initial paper in March, following up with a new version last month that notes mutually owned guarantors — like the kind envisioned in the DeMarco-Bright paper — have drawbacks. It requires large lenders to put up more capital to cover their operational and credit risk.
"Putting up the significant capital needed to cover the credit risk taken on by the mutual will also make mortgage lending a riskier and less profitable business for all lenders," according to the new paper written by Parrott, Sperling, Zandi, Ranieri and Zigas.
If the larger "lenders do not have a comparable level of control, they will be uncomfortable lending through this channel any more than they have to, as they will be putting significant capital on the line to cover the risk and management decisions of those with much less at stake," the five co-authors said.
Such a model could drive up mortgage costs and constrain access to credit, the authors warn.
The five authors are calling for a merger of Fannie and Freddie into a government corporation.
The "costs of merging the GSEs are steadily declining as the FHFA works to harmonize their activities, including the representation and warranty framework, capital levels, and other standards," according to the five mortgage sector experts.
"More important, however, is their adoption of a common securitization platform and single security, which is well under way and will offer a useful starting point for a more comprehensive effort to unify their activities."
The five co-authors considered several alternatives before unveiling their plan, suggesting that they initially balked at merging Fannie and Freddie.
"It was not our first instinct. As we worked through all the options, it quickly became apparent that each of the alternatives faced pretty significant hurdles," Parrott said Wednesday.
"The hurdles the government corporation faces are lower and more manageable than the mutual or utility alternatives," he said in the interview. "That is the bottom line of the paper."
Under FHFA's direction, Fannie and Freddie are already working towards creating a common securitization platform and a single mortgage-backed security that could facilitate a merger of the two GSEs.
A government corporation with separate funding also avoids the risks associated with the Federal Housing Administration, which is often tied up by fights in Congress over its resources.
The five authors acknowledge that merging Fannie and Freddie will be challenging and costly. However, "it represents something of a middle way, offering structural reform with as much continuity and as little disruption as possible."
If policymakers place the merged entities into a government agency like FHA, then all bets are off. "Then the costs of such a system likely vastly outweigh the benefits," the paper says.
