Thursday, May 16, 2013

Senate hearing shows government guarantee necessary, explores options for private capital bearing mortgage risk

by Ethan Handelman, National Housing Conference

The Senate Banking Committee’s Subcommittee on Securities, Insurance, and Investment heard testimony on Tuesday from a range of experts on mortgage finance. Senators in attendance, all with thoughtful questions, were Jon Tester (Chair, D-MT), Johanns (Ranking, R-NE), Jack Reed (D-RI), Mark Warner (D-VA), Elizabeth Warren (D-MA), and Bob Corker (R-TN). The title of the hearing “Returning Private Capital to Mortgage Markets: A Fundamental for Housing Finance Reform” accurately represents the theme of the questions and testimony, which focused on different mechanisms for causing private capital to bear risk ahead of government.

The witnesses largely agreed that in the short term, a continued government guarantee role was necessary to enable mortgage markets to function and that change should come gradually. Although several witnesses suggested that eventually government backing could be removed entirely, Mark Willis observed that at some point the cost in reduced access and affordability might not be worth further reduction of the government’s role.

Senator Warren encapsulated the discussion by observing that all the witnesses favored a layering of risk with private capital ahead of an explicit government guarantee paid for by a fee. The witnesses vary in their recommendations for getting the pricing of the guarantee right and the mechanisms for layering risk, and each has concerns about the incentives and loss-bearing capacity of the entities bearing risk.

Senators explored several structures for risk-layering, including an A-piece/B-piece structure similar to the Freddie Mac K-series, credit-linked notes, and an insurance-based model, with Senators Corker and Warner particularly interested in the A/B structure. Questions also raised issues of how and when mortgage limits should come down, what we should look for as FHFA causes Fannie Mae and Freddie Mac to test risk-sharing structures, and whether requiring private capital first limits government’s ability to step in when private capital flees.

The hearing closed on an optimistic note, as Senator Warren raised the possibility of data-tagging as a new source of much better information on loan performance that could inform future regulation.

List of witnesses with links to testimony plus archived webcast:
  • Dr. Mark A. Willis [view testimony]
    Resident Research Fellow
    Furman Center for Real Estate and Urban Policy, New York University
  • Mr. Andrew Davidson [view testimony]
    Andrew Davidson & Co. Inc.
  • The Honorable Phillip L. Swagel [view testimony]
    Professor of International Economic Policy
    University of Maryland School of Public Policy
  • Dr. Robert Van Order [view testimony]
    Department of Finance and Professor of Finance and Economics, George Washington University School of Business

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