US Report: Repairing America’s broken mortgage system


By Jill Fraser for Lending Central

It’s been tipped to be the biggest shake-up the US housing finance market will have seen in generations.

This week US Treasury Secretary Tim Geithner announced a plan for “fundamental reform”, which proposes winding down its $US142 billion portfolio of mortgage bonds guaranteed by government sponsored entities Freddie Mac and Fannie Mae by selling off up to $10 billion per month in agency-guaranteed mortgage-backed securities (MBS).

A US Treasury Department statement said that sales would begin this month, subject to market conditions.

“We will exit this investment at a gradual and orderly pace to maximize the recovery of taxpayer dollars and help protect the process of repair of the housing finance market,” said Treasury official Mary Miller.

The MBS, secured by mortgage giants Fannie Mae and Freddie Mac, were part of the financial sector bailout in 2008-2009.

Geithner’s announcement came off the back of a report to Congress last month by the U.S. Treasury in conjunction with the Department of Housing and Urban Development outlining what caused the US housing bubble, which generated the Global Financial Crisis, and how to ensure it never occurs again.

The Treasury’s recommendation that the government withdraw its support from Freddie Mac and Fannie Mae (shrink its footprint in housing finance) and allow the private mortgage market to step in to the sector and address consumer protection and increased transparency has been met with cautious optimism.

The report delineates the Obama Administration’s plan to reform America’s housing finance market “to better serve families and function more safely in a world that has changed dramatically since its original pillars were put in place nearly eighty years ago”.

The plan is to dramatically transform “the role of government in the housing market. In the past, the government’s financial and tax policies encouraged housing purchases and real estate investment over other sectors of our economy, and ultimately left taxpayers responsible for much of the risk incurred by a poorly supervised housing finance market”.

It is suggested that going forward, the US government’s primary role should be limited to “robust oversight and consumer protection, targeted assistance for low- and moderate-income homeowners and renters, and carefully designed support for market stability and crisis response”.

To quote from the report:

Under our plan, private markets – subject to strong oversight and standards for consumer and investor protection – will be the primary source of mortgage credit and bear the burden for losses. Banks and other financial institutions will be required to hold more capital to withstand future recessions or significant declines in home prices, and adhere to more conservative underwriting standards that require homeowners to hold more equity in their homes. Securitization, alongside credit from the banking system, should continue to play a major role in housing finance subject to greater risk retention, disclosure, and other key reforms. Our plan is also designed to eliminate unfair capital, oversight, and accounting advantages and promote a level playing field for all participants in the housing market.

Our plan helps ensure that our nation’s economic health will not be jeopardized again by the fundamental flaws in the housing market that existed before the financial crisis. At the same time, this plan recognizes the fragile state of our housing market and is designed to ensure that reforms are implemented at a stable and measured pace to support economic recovery over the next several years.

It is noted that the Obama Administration will also “mobilize all tools available to address the nation’s broken system of mortgage servicing and foreclosure processing” in an attempt to “help restore trust in the underlying foundation of the mortgage market.

Whilst not pointing a finger at any single cause of the housing crisis the report cites: “Misbehavior, misjudgments, and missed opportunities – on Wall Street, on Main Street, and in Washington” all coming together to push the economy to the brink of collapse. It stated that fundamental flaws need to be addressed and corrected in order to protect American citizens.

· Poor consumer protections allowed risky, low-quality mortgage products and predatory lending to proliferate:

· An inadequate and outdated regulatory regime failed to keep the system in check:

·A complex securitization chain lacked transparency, standardization, and accountability:

· Inadequate capital in the system left financial institutions unprepared to absorb losses.

· The servicing industry was ill-equipped to serve the needs of borrowers, lenders, and investors once housing prices fell.

The options being contemplated by the Obama administration to replace Freddie and Fannie are:

·Increasing guarantee fees to bring in more private capital.

·Increasing private capital ahead of Fannie Mae and Freddie Mac guarantees.

·Reducing conforming loan limits.

·Winding down Fannie Mae and Freddie Mac’s investment portfolio.

The Treasury report acknowledges that restoring trust and integrity in the broader U.S. housing market will require greater consumer protection across the board, but specifically in mortgage servicing and foreclosure processing, which will entail establishing national standards for mortgage servicing.

The report stated that the range of ways other countries support housing finance was taken into consideration.

Though there are lessons to be drawn from the diversity of systems, they are complex, the report noted.

“In most countries lacking a widely available guarantee or other means of direct government support, mortgages are financed through the banking system, which often enjoys indirect government backing. Some countries utilize their regulatory framework, or establish firm underwriting standards, to promote liquid mortgage markets. And some countries, particularly in Europe, use so-called covered bonds to channel credit to housing.

Like the U.S., several countries have government-supported entities that guarantee or hold mortgages, though in none are they as large as they have historically been in the United States. The U.S. is also the only high-income country in which securitization plays a major role in housing finance. In countries where securitization is present, it generally plays a smaller role and takes different forms than those we are familiar with in this country. The U.S. system, however, is one of the only countries in the world where the majority of mortgages are pre- payable, 30-year fixed-rate mortgages.”

The conclusion was that although international comparisons offer “useful lessons and new ideas” most would mean a “trade-off between four key factors that Treasury believes are required to create a system that constitutes Americans’ housing needs. They are: 1) access to mortgage credit, 2) incentive for investment in housing, 3) taxpayer protection, 4) financial and economic stability.

The report stated: “Complete privatization would limit access to, and increase the cost of, mortgages for most Americans too dramatically and leave the government with very little it can do to ensure liquidity during a crisis. Near-complete nationalization runs too high a risk of crowding out private capital, distorting investment decisions, and putting too much taxpayer money at risk.”

The Obama Administration maintains that the right course for America falls between these two extremes.

With that in mind, the report recommends three possible courses for long-term reform.

Option 1: Privatized system of housing finance with the government insurance role limited to Federal Housing Administration (FHA), USDA and Department of Veterans’ Affairs’ assistance for narrowly targeted groups of borrowers

This option would dramatically reduce the government’s role in insuring or guaranteeing mortgages, limiting it to FHA and other programs targeted to creditworthy lower- and moderate- income borrowers. While the government would continue to provide access for this targeted segment of borrowers, it would leave the vast majority of the mortgage market to the private sector.

Option 2: Privatized system of housing finance with assistance from FHA, USDA and Department of Veterans’ Affairs for narrowly targeted groups of borrowers and a guarantee mechanism to scale up during times of crisis

As in the above option the government’s overall role in the housing finance system would be dramatically reduced. In this option, however, the government would also develop a backstop mechanism to ensure access to credit during a housing crisis.

Option 3: Privatized system of housing finance with FHA, USDA and Department of Veterans’ Affairs assistance for low- and moderate-income borrowers and catastrophic reinsurance behind significant private capital

Under this option, as in the previous options, the mortgage market outside of the FHA and other federal agency guarantee programs would be driven by private investment decisions with private capital taking the primary credit risk. However, to increase the liquidity in the mortgage market and access to mortgages for creditworthy Americans – as well as to ensure the government’s ability to respond to future crises – the government would offer reinsurance for the securities of a targeted range of mortgages.

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  1. Well responsible borrowing does not come into play here. All the power and decision making comes from the banks and the government (consumer goodie too shoe lobbing groups and self interest banking executives). They know better than the individual borrower who understands their own borrowing capacity to repay! It is about time the balance flowed the other way – in 40 years of dealing with everyday Australians and their banking needs (savings and loans) I know that most people entering into loans they apply for know that at that particular point in time they can afford to repay their commitment. Their is no honesty in our current banking system and that needs to change. Banks can be as inefficient as they like no consumer can make them accountable.


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