Congress is about to begin addressing the long-overdue issue of housing-finance reform this week, but don't get too excited: It's probably going to take several years before anything meaningful gets done about the two giant gorillas in the housing-finance debate - Fannie Mae
The US Treasury Department is expected to issue a long-awaited and long-overdue white paper on how to improve the current housing-finance model sometime this week. On Wednesday, the House Financial Services Committee plans to hold its first of several hearings on the so-called government-sponsored enterprises, or GSEs, which provide government backing for mortgage bonds.
In the near term, a few issues will be addressed that have significant consequences for homeowners but fall far short of a fundamental housing finance fix.
The first applies to "conforming loan limits," which determine how expensive a home can be and still qualify for federal support. Congress passed a law in 2008 that temporarily lifted such limits to $729,750 in high-cost areas. But in September of this year, the limit will fall back down to the previous ceiling of $625,000 unless Congress acts to alter it. It seems that there's something like a consensus on this issue, with both sides agreeing that conforming limits need to come down, perhaps even lower than the previous ceiling.
In a speech on Monday, Representative Scott Garrett (R, NJ), who chairs a subcommittee on GSEs, pointed out that, to afford a home of that value, a family would have to earn about $250,000 per year.
"These are the same people that the president wants to raise taxes on," he said. "It doesn't make much sense to raise taxes on those families because they are too "rich" and then turn around and have the government subsidize them when they want to buy a house!"
While Garrett is on the conservative side of the GSE issue - saying on Monday that he's "firmly committed to a purely private US mortgage market" - it seems that the Obama administration and congressional Democrats are on the same page insofar as conforming loan limits go, according to FBR analyst Edward Mills.
Another key issue that will probably gain traction in the near term is defining the terms of a qualified residential mortgage, or QRM. Such types of loans will be exempted from a new regulatory requirement that securitizers retain 5% of the mortgage loans they pile into bonds. The Securities and Exchange Commission is expected to issue a draft rule on the QRM later this month.
If the SEC adopts a narrow definition, then more loans may be shifted toward the Federal Housing Administration, thus working against the goal of less government involvement. However, the SEC is expected to issue a broad definition, according to Mills.
Mills and others also expect the push for affordable housing that helped to capsize Fannie and Freddie to change in nature to affordable rentals, rather than affordable purchases. The subprime crisis made clear that not everyone can afford to be a homeowner.
Experts on Capitol Hill also expect that, over the longer term, the Treasury Department will call for a significantly reduced government presence in the mortgage market -- perhaps standing behind just 50% of mortgages, down from today's level of more than 90%. This would seem to meet the nationalization advocates and free-market enthusiasts halfway, precisely.
"If there is one area of agreement," says Mills, "it is that ultimately the government has to reduce its role in the housing market, because quite frankly it cannot increase."
But knowledgeable observers believe, with good reason, that little will be accomplished legislatively towards that goal before January 2013.
First, because Fannie and Freddie have unlimited government support until that time. Second because the executive and legislative branches of government will be too consumed by the 2012 elections to get anything done before then.
"Overall, we continue to expect a gradual reform process with a decent chance that nothing happens until after the 2012 elections," RBS analyst Margaret Kerins wrote in a report last week.
In the near-term, Kerins says the upcoming hearings "are likely to result in political posturing and headline risk," but not much else. FBR analyst Edward Mills says he expects "an uptick in Congressional hearings," with a few minor issues being addressed legislatively. Moody's analyst Brian Harris is holding steady his triple-A credit ratings on GSE bonds with a positive outlook because their forecasts only apply to the next 12 to 18 months.
Most analysts don't expect Congress to even begin discussing meaningful reform until the elections are over.
There are several proposals on the table to tackle housing-finance reform, but they generally fall into three silos: Privatization, nationalization and extending the status-quo. Republicans prefer the first option, Democrats the second. But because neither would be politically saleable, the U.S. is likely to maintain the current GSE model with a few tweaks.
"In regards to the structure of GSE reform, we believe that some sort of hybrid structure is most likely," Harris said recently. "While this could retain some of the features of the current model, it is more likely to be differentiated by a greater number of 'GSE-like entities' with a new form of ownership, and a government guarantee on mortgage-backed securities (MBS)."
It should become more clear where the Obama administration stands once the Treasury Department issues its belated white-paper, which has yet to appear though the Dodd-Frank regulatory reform bill had required by the end of January. The main challenge in getting from point A to point B in reforming the GSEs - or rather, back to point A if the hybrid model survives - is of a political nature.
The government appears to have two reform goals: To ensure the affordability and availability of mortgage financing and to limit the government's role in housing finance, thereby reducing the risk of taxpayer bailouts in the future.
However, the two goals conflict with one another. Removing government support will raise the cost of home-ownership and make mortgages less available, while extending support will continue the "heads, investors win, tails, taxpayers lose" model that has subsisted since the GSE structure was first implemented.
Republicans say they'd like to get the government out of the housing market completely while Democrats say that robust government support is necessary. But neither side is eager to bear the consequences and criticism of what meaningful reform would do to the housing market.
For the banking industry's part, big banks are pushing for a plan that would get rid of the GSEs and allow banks to dominate every aspect of housing-finance -- but still keep explicit federal guarantees on mortgage debt.
The three biggest players in the U.S. mortgage market, Bank of America (BAC)
Harris is betting that, instead of Democrats and Republicans reaching some kind of bi-partisan compromise on their own, the bond market will force the issue in January 2013. At that point, the government's support for Fannie and Freddie will change from an unlimited amount to a fixed amount, under terms of their conservatorship agreement with the Treasury Department.
"The catalyst for GSE reform will be the debt markets rather than the government," says Harris.
So far, Fannie and Freddie have borrowed $150 billion from the Treasury Department to stay afloat. Even though their credit-related losses are likely to be a nonissue by 2013, the two firms will still owe the Treasury between $21.8 billion and $33.6 billion in preferred dividends per year - which, ironically, they've been paying down by borrowing from the Treasury Department. Harris points out that neither firm's earnings have been large enough, even in good times, to pay down such dividends. The uncertainty about how Fannie and Freddie will fund their obligations will likely lead investors to demand higher rates for their debt, which, in turn, would pass through to higher mortgage rates.
"Clearly, the failure of the GSEs' financial model including their inability to service their preferred dividends over the longer term, mean that reform must occur at some point," he says.