Cheat sheet: Trump administration’s road map for GSE overhaul

WASHINGTON — The Trump administration has taken a long-awaited stance on how it envisions a future housing finance system, and it resembles legislative proposals enabling Ginnie Mae to back multiple private-sector guarantors.

The Treasury Department made clear in a much-anticipated report that its ultimate preference is for Congress to take up reform of the government-sponsored enterprises. That legislation would include an explicit government guarantee, and a new Ginnie-provided backstop for guarantors competing on par with Fannie Mae and Freddie Mac.

Still, the 53-page report also backs reforms that federal agencies, including the Federal Housing Finance Agency, could take without legislation. And while the administration’s first choice is for Congress to implement an explicit guarantee, it does not view that provision as a requirement for Fannie Mae and Freddie Mac to exit conservatorship, according to the report.

"Although Treasury does not believe a Government guarantee is required, Treasury would support legislation that authorizes an explicit, paid-for guarantee backed by the full faith and credit of the Federal Government that is limited to the timely payment of principal and interest on qualifying mortgage-backed securities," the report said.

Jasper Juinen/Bloomberg

The document recommends 49 administrative and legislative reforms. It has a clear preference for lawmakers to reach a deal on comprehensive changes, but also includes suggestions of what federal agencies can do in the meantime. The Department of Housing and Urban Development released its own set of recommendations, including that Congress give more autonomy to the Federal Housing Administration.

Notably, Treasury laid out several conditions that it believes must be met before Fannie and Freddie are released from conservatorship, including strengthening the GSEs' capital, completing an agreement to pay back the federal government, heightened prudential requirements and safeguards against disruption for Fannie or Freddie's MBS.

Treasury has also recommended that the administration work to make already-instituted reforms at Fannie and Freddie permanent, such as a cash window for smaller lenders and a permanent ban on volume-based discounts.

President Trump directed Treasury and the Department of Housing and Urban Development in March to draft the reports with the aim of releasing the government’s control on Fannie and Freddie and promoting sustainable homeownership.

“The Trump Administration is committed to promoting much-needed reforms to the housing finance system that will protect taxpayers and help Americans who want to buy a home,” said Treasury Secretary Steven Mnuchin in a press release.

Yet despite the administration's stamp on GSE reform talks, comprehensive reform still faces an array of obstacles. The administration may have succeeded in putting its goals on paper, but the status quo largely remains the same. With a presidential election around the corner and a full legislative calendar, it is unlikely that Congress will enact the recommended reforms anytime soon. It is instead much more probable that the agencies will plow ahead on making discrete changes.

Here is a fuller breakdown on the key recommendations:

Enhance taxpayer protections

Central to the report is the idea that taxpayers should never be on the hook for another government bailout, and the primary way to do that is to recapitalize the GSEs to ensure that Fannie and Freddie —and their successors — have enough capital to survive a severely adverse scenario.

While Treasury did not weigh in on the proposed capital framework under review by the FHFA, it did recommend implementing requirements that each GSE hold a certain amount of "high-quality liquid assets," and that FHFA revisit its resolution framework for the mortgage companies.

Treasury offered several options for recapitalization, including putting Fannie and Freddie into receivership and issuing shares of common or preferred stock.

In order to avoid a repeat of government conservatorship, FHFA should consider convertible debt or other long-term debt that could be bailed in to guarantee that taxpayers are protected, while shareholders and unsecured creditors would bear losses, the report said.

Treasury included a number of recommendations for amendments to the preferred stock purchase agreements as well, including addressing the periodic commitment fee.

In 2012, the FHFA and Treasury altered the senior agreements to require Fannie and Freddie to deliver nearly all of their profits to the Treasury Department in an effort to repay taxpayers, leaving the GSEs with an incredibly small capital cushion of $3 billion each.

That provision, also known as the net worth sweep, will likely be adjusted in order to facilitate recapitalization, the report said.

FHFA Director Mark Calabria has repeatedly emphasized his desire for the GSEs to hold more capital commensurate with their risk, and has said he planned to begin negotiating changes to the preferred stock purchase agreements with Treasury after the release of the administration’s report.

“Treasury expects that it will be necessary to maintain limited and tailored Government support for the GSEs by leaving the PSPA commitment in place after the conservatorships," the report says. "The Federal Government should be compensated for its continued support through the periodic commitment fee, as originally established by the PSPAs."

But if the GSEs were properly capitalized, they would only need to draw on that committment fee in severe circumstances. Ideally, this would be replaced by an explicit guarantee if Congress chose to enact one, Treasury said.

"In addition to preserving what works in the housing finance system, keeping each PSPA in place would have the benefit of preserving a mechanism for recouping any funding that might be extended by Treasury to a GSE in the future while ensuring taxpayers are compensated for committing to provide that support," the report said.

For the Federal Housing Administration, HUD plans to bolster its Mutual Mortgage Insurance Fund by strengthening its reverse mortgage program, which has historically threatened to drop the agency’s capital reserve ratio below the statutory minimum of 2%.

Ginnie Mae is also requesting the authority to adjust guarantee fees within a narrow band to further address risk, a senior HUD official said.

The department additionally is proposing a sustainable scorecard for homeownership to track the performance of loans over time, to confirm that borrowers are taking out loans they can indeed afford.

Meanwhile, Treasury has recommended that Congress replace the statutory affordable housing goals with an improved and more transparent mechanism to support underserved borrowers.

Define a limited role for the federal government

To be clear, Treasury appeared to back the consensus that a government backstop should remain part of a future system. This would ideally be accomplished through authorizing Ginnie Mae to be the mechanism for recouping catastrophic losses.

Yet the report envisions private capital as being more responsible to protect against losses, as opposed to taxpayers.

Only Congress could establish Ginnie as a new backstop, but in the meantime Treasury suggested that FHFA, along with Ginnie, review Ginnie's operational capacity and existing infrastructure.

But to reduce the government's role, Treasury also suggested that the administration consider restricting support in the preferred stock purchase agreements for some subsets of single-family mortgage transactions, like second home financing, cash-out refinances and higher-balance loans.

Additionally, the report recommends that Treasury and FHFA consider limiting Fannie and Freddie's multifamily footprint, or restrict its multifamily business to only serve the GSEs' affordability goals.

Replace the QM patch

Treasury also addressed how the Consumer Financial Protection Bureau’s mortgage underwriting regulation should be applied to GSE-backed loans in the future.

Currently, loans backed by Fannie and Freddie enjoy a statutory exemption from the CFPB’s ability-to-repay rule. Those loans are considered “qualified mortgages” under the CFPB rule, even if they exceed QM’s standard debt-to-income maximum of 43%.

That exemption, known as the QM patch, is set to expire in 2021 and the Treasury report endorsed the CFPB’s view that the patch should expire. But Treasury also called for “further revisions to the ATR rule to ensure that mortgage lenders continue to have a bright line safe harbor after expiration of the QM patch.”

For example, the report said Appendix Q, a set of preexisting guidelines used to comply with the CFPB rule, should be “revised or removed,” the report said. Yet Treasury also noted that such revisions might be insufficient.

“Congress and the CFPB should consider alternative approaches to establishing bright line safe harbors for ATR compliance that do not rely on prescriptive underwriting requirements,” the report said.

One option would be to set a simple threshold for financing cost, below which a loan is considered QM. Another option would be to establish that a loan is QM “after a specified seasoning period.”

Increase the role of the private sector

The report called on policymakers to address regulatory gaps between the GSEs and private-market competitors. For example, the FHFA could align the GSEs' credit risk capital charges with those of other regulated institutions for similar assets. The report also suggested the Financial Stability Oversight Council could have a role in aligning the GSEs and private banks' regulatory regimes on an interagency basis.

According to a senior Treasury official, the GSEs are provided with a generous amount of capital for their credit-risk transfer, while banking organizations are not. As such, the report recommends that any guarantor or GSE should be granted appropriate capital relief if they transfer mortgage credit risk via credit-risk transfer.

Although small lenders have generally preferred a utility model over a multi-guarantor model as the center of the housing finance system, Treasury proposed that the administration solidify several changes made during conservatorship to level the playing field in amendments to the PSPAs.

That would include embedding the cash window — which lowers the pricing for lenders to sell loans directly to the GSEs through — in the framework, as well as the ban on volume-based discounts that were commonplace before the financial crisis.

Treasury additionally recommended that Fannie and Freddie and their successors have a nationwide servicing requirement.

The report also suggested legislation to expand the Federal Home Loan Bank system to include more permitted categories of FHLB members, and that FHFA revisit its controversial rule that excluded captive insurers from being FHLB participants.

“With the continued evolution of the housing finance system, there might be some question as to whether the current statutory and regulatory restrictions on FHLBank membership continue to be well-tailored to the housing and community development mission of the FHLBanks,” the report said.

Give FHA more autonomy

HUD’s recommendations, meanwhile, focus on the future of the FHA. HUD called on Congress to give FHA more independence as an autonomous corporation within HUD.

HUD appears to want to return the agency back to its historic role of serving low- and moderate-income borrowers. In fact, the department has proposed that Congress establish FHA, the Department of Veteran Affairs and the Agriculture Department as the “sole source of low downpayment financing for borrowers not served by the conventional market.”

Administratively, HUD suggested it will look at, in coordination with FHFA, the roles and overlap between FHA and the GSEs, particularly with respect to loans with high debt-to-income ratios and cash-out refinances.

“Critically important to these overlaps is care by FHA that its government-subsidized premiums … do not undercut private-sector pricing for large segments of mortgage loans that can be well-served by private capital,” HUD said in its report.

HUD also indicated that it will continue to push for several reforms that it has already expressed a desire for, like much-needed technology upgrades and coordination with the Justice Department on the enforcement of the False Claims Act.

The report also suggested that Congress should separate the reverse mortgage program from FHA’s Mutual Mortgage Insurance Fund.

“This would provide for more transparent accounting of program costs and decrease cross-subsidization that occurs with mission borrowers in the forward mortgage portfolio,” the report says.