U.S. Treasury Outlines Housing Finance Proposals

by Jann Swanson, Mortgage News Daily, 4/16/10
http://www.agentopolis.com/icontent/iframe.html?tmurl=http://www.mortgagenewsdaily.com/04152010_financial_reform.asp

"Reform is coming," according to a Treasury Department official who spoke this week to the National Policy Conference 2010 held by the Mortgage Bankers Association in Washington, DC.

Michael S. Barr, Assistant Secretary for Financial Institutions, recapped events leading up to the collapse of the mortgage market and the economy, and gave conference attendees some background on regulatory changes currently under consideration.

Barr said that the country had a near catastrophe because "private risk-taking led to a race to the bottom unconstrained by either market discipline or government oversight," and to a vicious cycle of deteriorating standards in lending practices. And nowhere, he said, was this more apparent than in the mortgage market.

"There were inadequate rules, inadequate monitoring, and inadequate enforcement on all levels of the mortgage market," and the resulting unsafe practices appeared first among nonbank originators [e.g. vertically integrated home builders with their own mortgage companies] because that is where regulation was weakest.  However, independent mortgage lenders and brokers did not act alone to relax standards. They responded to a strong push from Wall Street which was in its own race to the bottom, generating increasingly vulnerable and ultimately foolhardy finance products. And here too, he said, lax and inconsistent oversight left the system open to this vicious cycle with supervision fragmented over four different agencies. This slowed responses to problems and invited regulatory arbitrage, "and so the explosive growth of the less regulated sectors of the housing finance system applied pressure on the regulated sector.

"Fannie and Freddie were eventually caught up in this destructive race," he said. They had lost their market share and made poor strategic choices trying to get it back. He refuted claims that the GSEs collapsed because of the government's imposition of affordable housing goals. "Affordable housing goals did not drive the GSEs to the poor decisions that caused them to fail. (They) relaxed standards for the same reasons other market participants relaxed standards: old-fashion greed and flawed regulation."

[HOT: The lack of regulatory oversight encouraged this greed by reducing both the chances of getting caught and the punishment if caught. With personal risks so low and the profit potential so high, is it any wonder that people took advantage of whatever loopholes they could find?]

Barr said that the path to housing recovery will be painful and a stable and lasting recovery requires comprehensive financial reform. Reform, he said "is about security for families in their savings. It's about laying the foundation for investment in our small businesses and entrepreneurs. It's about promoting the growth we need to create jobs. That is why each month, each week, each day; the legislation that will bring reform is gaining momentum. Reform is coming." 

The Assistant Secretary said it is important to remember that the financial regulatory system today is virtually the same system that allowed the race to the bottom and it still has the same gaps and loopholes that allowed firms like Bear Stearns and Lehman Brothers to build up excessive leverage and escape meaningful consolidated supervision. "The key test of the sufficiency of any reform proposal is whether it reduces the risk of races to the bottom; whether it substantially reduces the potential for regulatory arbitrage and the incentives for regulators to lower standards."

The President's reform plan, he said, does that.

He said that claims that the Senate banking bill would lead to permanent bank bailouts are flatly false. It explicitly mandates that a failing financial firm would be sold off, broken apart, and liquidated; that culpable management would be replaced, creditors would suffer losses, and shareholders would be wiped out.  By requiring assessments on the industry to recoup losses, the firms themselves, not taxpayers, would bear the costs when a firm fails. The "Dodd" bill also limits the Federal Reserve Board's emergency lending authority and specifically prohibits its use to aid a failing financial company.

Barr said that rather than encouraging the market to view some firms as "too big to fail," the government, for the first time, will have the authority to impose tough standards on capital, liquidity, concentration, and disclosure and will also have the tools to wind down even the largest firms. "Chairman Dodd's bill ensures that no firm will be insulated from the consequences of it actions and no firm will be protected from failure."

The President's plan also reduces the risk of races to the bottom in consumer protection, he said. Under the current system seven different federal agencies have authority in the area and 15 times more money is allocated to overseeing compliance with consumer laws by banks than by non-bank financial service providers. The new bill will establish a single independent bureau with a clear mission of preventing abusive and deceptive practices and promoting transparency and consumer choice.  This will mean an end to the ability of services to shop for the weakest regulatory agency and it means the government will be able to act much faster to address dangerous emerging issues such as subprime teaser-rate mortgages.

He said that some people have questioned consolidating oversight of mortgage origination with jurisdiction of other non-mortgage markets, but excessive credit card and auto lending fed an irresponsible wave of cash-out refinancing and home equity loans earlier that have left millions of homeowners under water. "We must build solutions that respect these connections among markets and products."

The third issue, Barr said, is regulating financial markets including derivatives. The President's plan provides for strong regulation and transparency for all derivatives and standard ones will be centrally cleared and traded. Over the counter derivative dealers and major swaps participants will be subject to strong prudential standards including capital and margin requirements.

Reforming the housing finance system must address what he called its ultimate instability. The administration's proposals will be designed to achieve four objectives.

1. Mortgage credit should be available and distributed on an efficient basis to a wide range of borrowers.
2. A well-functioning housing market should provide affordable housing options, both ownership and rental, for low and moderate-income households.
3. Consumers should have access to mortgage products that are easily understood.
4. The system should distribute the credit and interest rate risk in an efficient and transparent manner that minimizes risk to the broader economic system an does not generate excess volatility or instability.

Barr concluded by saying that the urgency of reform is increasing - not decreasing - as the crisis recedes. "We have a choice to enact the strongest, most important financial reforms since those that followed the Great Depression.  We need to get the job done so that our country can focus its full attention on healing the damage that has been inflicted and building a sustainable economy for the future."

THE ADMINISTRATION WANTS YOUR OPINION 

The Obama Administration will seek input in two ways. First, the public will have the opportunity to submit written responses to the questions published in the Federal Register online at www.regulations.gov.  Second, the Administration intends to hold a series of public forums across the country on housing finance  reform.

Questions for Public Input:

1. How should federal housing finance objectives be prioritized in the context of the broader objectives of housing policy?

Commentary could address: policy for sustainable homeownership; rental policy; balancing rental and ownership; how to account for regional differences; and affordability goals.

2. What role should the federal government play in supporting a stable, well-functioning housing finance system and what risks, if any, should the federal government bear in meeting its housing finance objectives?  

Commentary could address: level of government involvement and type of support provided; role of government agencies; role of private vs. public capital; role of any explicit government guarantees; role of direct subsidies and other fiscal support and mechanisms to convey such support; monitoring and management of risks including how to balance the retention and distribution of risk; incentives to encourage appropriate alignment of risk bearing in the private sector; mechanisms for dealing with episodes of market stress; and how to promote market discipline.

3. Should the government approach differ across different segments of the market, and if so, how?  

Commentary could address: differentiation of approach based on mortgage size or other characteristics; rationale for integration or separation of functions related to the single-family and multi-family market; whether there should be an emphasis on supporting the production of subsidized multifamily housing; differentiation in mechanism to convey subsidies, if any.

4. How should the current organization of the housing finance system be improved?

Commentary could address: what aspects should be preserved, changed, eliminated or added; regulatory considerations; optimal general organizational design and market structure; capital market functions; sources of funding; mortgage origination, distribution and servicing; the role of the existing government-sponsored enterprises; and the challenges of transitioning from the current system to a desired future system. [HOT emphasized the role of builder-owned morgage companies, their ability to sell the loan to Wall Street investors as mortgage-backed derivatives, and the resulting incentive to relax underwriting standards, push predatory lending practices, and ignore building codes and construction quality that could result in rapidly declining home values.]

5. How should the housing finance system support sound market practices?

Commentary could address underwriting standards; how best to balance risk and access; and extent to which housing finance systems that reference certain standards and mortgage products contribute to this objective.

6. What is the best way for the housing finance system to help ensure consumers are protected from unfair, abusive or deceptive practices?

Commentary could address: level of consumer protections and limitation; supervising agencies; specific restrictions; and role of consumer education. [HOT called for more transparency and simplicity in comparing finance options. Because the home buying process is far too complex - technically, financially and legally - adequate consumer protections are a MUST.]

7. Do housing finance systems in other countries offer insights that can help inform US reform choices?