History can repeat itself. For the past decade I have advocated for legislative GSE reform, a position taken by the Board of Directors of the Mortgage Bankers Association. What I observed both in a senior role at a GSE in the early 2000s, and subsequently watching behaviors in a state of conservatorship, has cemented my view.
Any reform without legislation would result in a world where winners and losers would be picked based on volume and preference of the GSE. A steady unleveling would return, as existed prior to the move under President Bush in 2008.
I worked at Freddie Mac from 1999 – 2005 as a Senior Vice President in the Single-Family business division. As a member of the executive team, the mandate given to me was clear. The company would “customize“ terms and offerings for many of its largest lenders. The remaining lenders would get “standardized“ terms in pricing, credit, and technology offerings.
What I saw during my tenure was a clear corporate bias in favor of larger lenders. This was driven largely by the better economics those relationships provided to Freddie Mac. In exchange for a commitment to volume or market share, many of the nation’s largest lenders would get preferred guaranty fees, negotiated buy-up and buy-down pricing, modified MAP (market adjusted pricing applied to the MBS trade value), reduced add-on fees for things like second mortgages, and more.
Beyond pricing, the largest lenders negotiated for reduced documentation waivers, permitting the use of their own proprietary AUS systems instead of Freddie’s Loan Prospector system. There were waivers for the cost of using the system as well. Credit waivers were doled out to the very few high-volume lenders (known as sellers) to be competitive with those given to Fannie Mae’s largest sellers as a means to retain the business.
In short, the economics of the GSEs helped drive a massive concentration of origination power for the largest lenders. Back then, very few knew how unlevel the playing field was for smaller lenders, and how inevitable the concentration was.
But it all became clear in conservatorship as the FHFA’s reports to Congress included an entry about the spread between all-in guaranty fees from the largest to smallest lenders.
In 2011, shortly after joining the MBA, I set up a meeting with Acting Director Ed DeMarco with the CEOs of three well known Independent Mortgage Bankers. The purpose was singular. We argued there should be no price disparity provided to any lender for volume, and that pricing should solely reflect credit risk. With Ed DeMarco, we found a sympathetic ear, and over the subsequent quarters the FHFA reported progressively narrower spreads in pricing between large and small lenders.
Today, we stand at a precipice of great change. Among the options offered for the path forward is simply returning Fannie and Freddie to their previous structure, albeit with some stepped-up regulatory oversight to protect against some of the activities that led to their collective failure in 2008. This could include increased minimum capital, limits to use of the portfolios, execution through the new Uniform Mortgage-Backed Security via the Common Securitization Platform, and more.
Some argue the “level playing field” in pricing and credit terms can be managed by the regulator, as it has been in conservatorship. Given my experience at Freddie, I’m deeply skeptical that this would work.
The economics of the two enterprises will continue to pull them strongly towards the larger lenders. While some regulators could counter these incentives with strong oversight, others may be less inclined or able to. If we’ve learned nothing else during conservatorship, it’s that what makes for sound oversight will vary strongly from one regulator to the next.
Between DeMarco, his successor Mel Watt, and now Mark Calabria, we have overseers who approach the job of FHFA Director very differently. When DeMarco led the agency from 2009 to 2013, he worked to scale down the size and scope of the multi-family businesses with steady reductions in the cap, and to raise guaranty fees. His final g-fee increase was reversed days after Mel Watt came to office.
It can be argued that everything has changed since I left Freddie Mac. After all, I have been gone for 14 years, and The Housing and Economic Recovery Act of 2008 passed after I left. HERA gives regulators more authority to protect the level playing field and improve transparency. Yet even in conservatorship, especially under the past Director, we have seen a slide back toward bespoke deals negotiated between Fannie and Freddie and those counter-parties that can offer them the best economics. Today, through the use of pilots, custom buy-up/buy-down pricing, negotiated custom cash window pricing and more, there are steps being taken that once again widen the gap between some lenders over others.
In conservatorship, we have seen specific examples of past behavior. When I led the MBA, we discovered that a GSE was giving preferred pricing and reduced LP fees to a select number of lenders. It was only corrected when we elevated our concern to the regulator.
We saw attempts to implement a direct-to-consumer marketing campaign, where the GSE would advertise directly to home buyers and then place itself in the middle of the transaction, referring them to local direct sellers. That was also pulled back, only after intervention by lenders and the MBA. These are just two amongst multiple examples where we have seen the slope get slippery.
I agree with the GSEs that pilots are often the only way to test new offerings before rolling them out to the entire market. But there is a balance between testing and transparency that could bring greater clarity to lenders about the terms of business they may be getting versus others. If a pilot creates a competitive advantage for a seller or small group of sellers, it should – at a minimum – be made clear how long it would last.
While each pilot – or waiver – likely makes good sense to the enterprises, they have a history of separating winners from losers in ways that reflect the interests of the enterprises over those of the housing finance system.
Relying on the intervention from large trade groups or other influential bodies is not a sustainable model to protect the long-term erosion that will eventually broaden the gap between large and small. And we have learned that FHFA Directors’ perspectives can change outcomes for transparency and parity.
The function that the GSEs perform for the housing industry is critical and necessary, but because taxpayers are backing the risk in a unique manner compared to any other capital source for mortgage finance, this system must come with obligations and limitations.
The only way to avoid distortions with any certainty is through legislation. Policymakers can hardwire a set of behaviors into the system that serve the interests of the nation, rather than just those of the enterprises.
The outline offered by Chairman Mike Crapo, for example, includes the mandate for level pricing with the elimination of discounts for volume. It proposes a legitimate capital standard to be established. It limits the purpose of the GSE portfolios, yet applies an explicit guaranty on the MBS.
We need debate on issues around commitment to affordable housing and the market structure, the number of guarantors, and the relationship between GNMA, FHFA, and the Common Securitization Platform. This legislative process could be one that might protect against consolidation – the outcome of the model before conservatorship.
Lenders and other stakeholders need to reflect on the previous regime and remember that history can and will repeat itself. To protect the generational impact of this reform process, we must ensure the permanence of some of the most critical issues before any consideration to recapitalization and release.
Anything more shortsighted threatens the common elements of a functioning government-supported housing finance system that most stakeholders should agree with. Whatever is decided will impact housing finance for decades to come.
David H. Stevens, CMB, is Contributing Editor at Mortgage Media, and former SVP of Single Family at Freddie Mac, former EVP at Wells Fargo Home Mortgage, former President and COO of the Long and Foster Realty Companies, former Assistant Secretary of Housing and FHA Commissioner, former CEO of the Mortgage Bankers Association