Fannie Mae and Freddie Mac have entered the New Year one “significant” step closer to their near half-decade old initiative to issue a common mortgage-backed security (MBS). Yet even as the two government-sponsored enterprises strive for a 2018 target launch, the passage of time and the shifting policy priorities of the GSEs’ government regulator has led to uncertainty as to just how effective the effort will be in reviving a struggling post-crisis secondary market.
Nearly five years after the Federal Housing Finance Agency (FHFA) first mandated the securitization of GSE single-family mortgages into a single, fully interchangeable security, Freddie announced last month it has gone live on the Common Securitization Platform (CSP) for bond issuance and bond administration for certain Freddie Mac Participation Certificates (PCs)
“The successful implementation of Release 1 is a significant milestone toward the ultimate goal of a common securitization platform and a Single Security,” noted FHFA Director Mel Watt.
Developed by Common Securitization Solutions (CSS) – a jointly owned affiliate of Fannie and Freddie – the CSP is a technology and operational platform designed to perform many of the back office functions for the Single Security. Time of the release of the GSE Single Security is intertwined with the completed development and full implementation of the CSP.
Freddie’s now established use of CSP software to issue its current securities, Release 1, paves the way for the transfer of Fannie’s MBS to the platform – a far more complicated prospect. Release 2 will enable the two firms to issue the new Uniform Mortgage-Backed Security (UMBS), through the CSP.
The potential result, say the GSEs, will enable Fannie and Freddie to transform their separate multi-trillion dollar to-be-announced (TBA) markets into a single $3.5 trillion TBA market, “second in size only to the global market for U.S. Treasuries.”
The FHFA is expected to announce its implementation timeline for Release 2 in the first quarter of 2017, pushed back from its initial fourth quarter 2016 announcement deadline. The Finance Agency has said it would provide at least a 12-month heads-up before implementation of the date of the single security.
Devil In The Alignment
The FHFA contends that the Single Security would bring additional liquidity and depth to the TBA market and eliminate trading disparities between the GSEs’ securities. Fannie has long enjoyed a significant liquidity advantage which has forced Freddie to offer a subsidy to keep its MBS competitive.
One of the key challenges in creating the Single Security remains the alignment of important and contractual business practices between Fannie and Freddie, according to Bob Ryan, FHFA acting deputy director, division of conservatorship.
Differences in how Fannie and Freddie create or administer the MBS they issue as Single Securities could result in price differentiation which could spur investors to not treat the MBS as fungible. Consequently, assuaging investors’ concerns about the Single Security is a top priority, Ryan told attendees of an Urban Institute housing panel in November.
“Investors want these single securities among the two issuers to be as fungible and as exchangeable as possible,” said Ryan. “That, by definition, means that they can feel comfortable trading in and out of these securities.”
Industry groups, including the Securities Industry and Financial Markets Association (SIFMA), have expressed their acute concern about a failure to sufficiently align GSE policies and procedures as a key impediment to the success of the Single Security.
“We believe that effective alignment of policies and practices, so as to achieve a continuing alignment of security performance, is the single most important factor in the success, or lack thereof, of this initiative,” noted SIFMA in a comment letter to the FHFA. “Any policy or practice of the GSEs that could impact prepayment speeds in a material way must be effectively aligned.”
On the flip side, others fear that too much alignment of GSE policies by the FHFA may force Fannie and Freddie to limit the types of innovative products and activities they could introduce. Ryan said that the Finance Agency is striving mightily to thread that needle between mandating policy alignment while preserving competitive innovation between the two GSEs.
“We have to reconcile the diversity of products and the diverging of processes and ideas in competition with the other side, which is aligning the securities to make sure the prepayments flow,” explained Ryan.
While acknowledging that past competition between Fannie and Freddie in some areas has been “counterproductive,” Ryan said the FHFA has been encouraging “small C” competition between the two firms to foster innovations in technology, customer service and access to credit.
“We like that kind of competition and we don’t want to align the enterprises and all those activities,” said Ryan. “The marketplace will tell use which one of those [innovations] succeed and which one don’t.”
When the Single Security and the CSP was initially proposed by the FHFA under then Acting Director Edward DeMarco in the agency’s 2012 Strategic Plan, the platform was intended to be open to any non-agency MBS user that wanted to use it as a means of making entry into secondary market easier for private entities.
When Director Watt took the FHFA over following Senate confirmation in 2014, the Finance Agency reformulated its goals for the conservatorships in many ways subtle but no less significant. Among other things, the FHFA narrowed the focus of its goal from creating a new secondary mortgage market infrastructure to primarily addressing the GSEs’ current operational needs.
Specifically, the FHFA after 2014 ceased its work on developing a model contractual and disclosure framework (CDF) for residential MBS securitizations. The Finance Agency said that the effort to develop the CDF was a distraction from the conservator’s focus on addressing Fannie’s and Freddie’s securitization infrastructure needs – particularly those related to the implementation of the Single Security.
A recent report by the Government Accountability Office (GAO) noted that the FHFA’s priority shift – which came after a string of profitable post-crisis quarters for both GSEs – has created no small amount of uncertainty about the future structure of the housing finance system.
“Rather than addressing barriers to entry for private entities, these actions may enhance rather than lessen the enterprises’ existing advantages, which serve as barriers to entry for private entities and add to market participants’ uncertainty about their role in the market relative to the enterprises,” said the GAO.
What is also far from certain is whether the CSP and GSE Single Security, once up and running, will perform as expected, according to Phillip Swagel, a professor at the University of Maryland School of Public Policy and former Assistant Secretary for Economic Policy at the Treasury Department under President G.W. Bush.
Swagel says there is understated but real concern that for all the time, technology and treasure invested into the CSP and Single Security project, it might just fail to perform or not perform as expected.
“It’s a complicated project with many moving parts. It’s great if it works, especially for Fannie and Freddie,” said Swagel. “But technically, if it doesn’t work as it’s supposed to it will cause problems.”
Since leaving the Finance Agency, Former Acting FHFA Director DeMarco – now a senior fellow at the Milken Institute – has called for the abandonment of the CSP project in its current form in favor of using the established, road-tested Ginnie Mae platform to issue government guaranteed MBS.
“At about the same time work on the CSP began, Ginnie Mae initiated an overhaul of its securitization platform. This work has produced an operating, multi-user single security wrapped in a federal guarantee,” DeMarco noted in a white paper last fall. “The CSP, on the other hand, has been focused on serving just Fannie and Freddie the past two years and is still more than a year from being fully operational for just those enterprises alone.”
Given the unknown duration of the GSE conservatorships and without Congress providing explicit direction for the future of Fannie and Freddie, GAO notes that another change in FHFA leadership “could again shift priorities for the conservatorships, which in turn could send mixed messages and create uncertainties for market participants and hinder the development of a broader secondary mortgage market.”
For the New Year, the GAO recommended that Congress take up legislation to establish clear objectives and a transition plan to a reformed housing finance system that enables the GSEs to exit government conservatorship.
“By setting clear direction for the future of housing finance reform system, Congress would enable FHFA to use the conservatorships of the enterprises to facilitate a new structure,” concluded GAO.