Credit Risk Transfer Plan Draws Mixed Reactions

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Dissident stockholders in Fannie Mae and Freddie Mac rolled out the heavy guns earlier this month to slow what appears to be a groundswell of support for the Federal Housing Finance Agency’s plan to reduce the government’s risk exposure by moving more private capital into the first-loss position ahead of the GSEs’ through expanded mortgage insurance.

On a teleconference call sponsored by Investors United, the rump group of private investors in the GSEs who are committed to the preservation of their shareholder rights, Timothy Howard, a former chief financial officers and vice chairman at Fannie Mae, warned that supporters of the FHFA’s plan are fooling themselves.

Those who tout risk-sharing securities as the future of mortgage securitization “are pretending that the face value of these securities is the equivalent of equity capital, when they’re worth less than one-tenth of what equity capital is worth because they absorb less than one-tenth of the credit losses,” Howard said.

“Saying you’ve transferred credit risk when you actually haven’t is a prescription for disaster. We tried fooling ourselves with securitizations before…We know how that turned out…There’s not much difference between hiding credit risk behind inflated ratings and pretending to have transferred it to investors when you know you really haven’t.”

(Howard, you might remember, was ousted along from Fannie Mae along with Chairman Frank Raines in late 2004 as the government worked to deal with the housing debacle. It also should be noted that he was never found guilty of any wrongdoing.)

Others also have concerns about front-loading the credit risk. The American Bankers Association, for example, is worried that the plan will “likely create the conditions for large lenders to effectively benefit from volume discounts, which have proven troublesome in the past,” the organization said in a comment letter to the FHFA.

A the same time, the ABA joined five other trade groups in another letter backing the FHFA’s efforts to test various credit risk transfers in its effort to attract private capital into the mortgage market and reduce taxpayer’s potential exposure to losses. The six groups maintain that the agency should continue to experiment with both front and back-end schemes.

“It is not yet the time and may never be the time to pick a winner,” the groups, which include the Mortgage Bankers Association, the Financial Services Roundtable, the Association of Mortgage Investors, the Securities Industry and Financial Markets Association and the Structured Finance Industry Group.

Meanwhile, in a separate comment letter of its own, the Mortgage Bankers Association praised the FHFA initiative and called for the agency to keep on. “Well-conceived upfront risk-sharing pilot programs can help GSEs better determine which transaction structures are best able to expand the sources of private capital and withstand both the peak and valleys in the credit cycle,” the MBA said.

Here are a few excerpts from comment letters from other key stakeholders:

* U.S. Mortgage Insurers – “Increasing the proportion of front-end credit-risk transfer (CRT)…will advance four key objectives of a well-functioning housing finance system by ensuring that: (1) a substantial measure of private capital loss protection is available in bad times as well as good; (2) such private capital absorbs and deepens protection against first losses before the government and taxpayers; (3) all sizes and types of financial institutions have equitable access to CRT; and (4) CRT costs are transparent, thereby enhancing borrower access to affordable mortgage credit.”

* National Association of Home Builders — “Deep coverage MI would allow mortgage insurance companies to reduce the Enterprises’ exposure to credit losses to as low as 50 percent of the mortgage loan amount. The Enterprises would reduce their guarantee fees on the mortgage loans commensurate with the cost of the risk they transfer to the mortgage insurers. The reduced guarantee fee charged by the Enterprises in exchange for incurring less credit risk can be passed on to consumers, reducing the cost of the mortgage loans and increasing the availability of credit.”

* Urban Institute: “The GSEs could share additional credit risk through this channel by having some MIs cover a deeper level of first loss…So-called deep cover MI has several attractive features. First, it extends a structure already in wide use, making it easy for lenders of all sizes to adopt. Second, in contrast to the front-end structures used to date, it is equally available to and can be equally priced for lenders of all sizes. Third, it is completely transparent… Since mortgage insurance is the only product MIs offer, they will provide capital in good times and bad.”

* Community Mortgage Lenders of America: “There is no substitute for the depth of experience, the broad web of customer relationships and level of service that the MI industry provides to lenders, nor to the key role played by mortgage insurers in facilitating low down payment lending for borrowers whose home finance needs are served with a low down payment mortgage.”

*Credit Union National Association: “… Private mortgage insurance needs to be maintained as an option as it can be utilized as an effective risk transfer strategy.”

* Housing Policy Council: “We specifically recommend that FHFA and the Enterprise test deeper mortgage insurance through a pilot program. Of the various structures discussed in the RFI, only deeper mortgage insurance has yet to be tested in the marketplace.”

This article was written exclusively for GoRion.

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This article has been exclusively written for GoRion by...

Lew Sichelman

Lew Sichelman

In his weekly column The Housing Scene, Lew Sichelman provides consumer-oriented information on housing and mortgages that is essential reading in today's market. Dubbed "the consumer's real estate columnist," Sichelman uses plain English to give readers information they can use, making The Housing Scene easily understandable for even first-time home buyers. His column, which appears in the Los Angeles Times, Chicago Tribune and many other newspapers, addresses a wide range of topics. He has been covering the market for more than 40 years and also writes for numerous trade publications.

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