How the Home Loan Banking System Wants Community Banks to Thrive in a New House Finance Reform Proposal
The season of spring is finally upon us following a nasty, brutish and long winter and politicos of all stripes are poised to jump into the political foray now that fair weather has emerged. In Washington the talk has turned to the question of what is to be done with Fannie Mae and Freddie Mac as a bipartisan effort is underway to reform the current housing finance market.
Following the mortgage bubble burst and the ensuing financial collapse, mortgage market giants Fannie Mae and Freddie Mac were placed into conservatorship under the Federal Housing Finance Agency (FHFA) in September of 2008. Since that time the entities have sent $202.9 billion back to the Treasury and the Office of Management and Budget has forecasted there is potential for an additional $179 billion in profit over the next ten years, were they to remain in conservatorship.
The conversation related to reform of the housing finance market is not new but rather has been stirring around the policy pot for several years. In 2013, Senate Banking Committee members Bob Corker (R-TN) and Mark Warner (D-VA) released a bi-partisan draft that has served as the foundation for a housing finance reform bill authored by Senate Banking Chairman Tim Johnson (D-SD) and Ranking Member Mike Crapo (R-ID), who released their draft in late March.
PACB sat down with FHLBank Pittsburgh President and Chief Executive Officer, Winthrop Watson, for a candid and insightful interview to discuss the merits of this recent proposal and its impact on the community banking industry.
Nick DiFrancesco (ND): Senate Banking Chairman Tim Johnson and Ranking Member Mike Crapo recently released their draft intended to address housing finance reform. The draft borrowed a lot from the Corker-Warner bill but contained additional provisions. What portions of the Johnson-Crapo bill do you see as being the most workable?
Winthrop Watson (WW): Since Fannie Mae and Freddie Mac were placed into conservatorship, the debate on what to do with them and the mortgage markets as a whole has moved forward. Some of the major proposals that we have seen include not only the Corker-Warner and Johnson-Crapo bills but also a bill in the House authored by House Financial Services Chairman Jeb Hensarling. Looking at Corker-Warner and now Johnson-Crapo as a policy continuum, the details of what a new mortgage finance infrastructure would be are increasingly coming into focus. It’s a very ambitious piece of legislation that attempts to create a template for one of the largest markets in the U.S. and, of great importance, also creates a very powerful regulator to oversee the process.
It’s heartening to see this happening on a bipartisan basis. The Senate Banking leadership and their staff have devoted literally thousands of hours on the bill and we can see that they are trying really hard to get this right. That’s kind of the big picture.
On the “what’s most workable” question, there are several concepts with some good underlying structural details that we think are very important. One is they’re working hard and creating the underpinnings to retain the conditions for a cost-effective 30-year fixed rate mortgage. That in turn requires trying to set the conditions for a liquid government-backed securitization program that creates a very deep and liquid secondary market in mortgages. As a country we need a very deep investor base to support the mortgage business and I think they’re taking a step in the right direction.
Another area that’s constructive is the concept of providing a private first-loss position to protect taxpayers and ensure these instruments will be strong credits. This is very constructive. Another way that we think the bill is very positive is that it supports the current structure for the Federal Home Loan Banks. The FHLBanks had a number of objectives in the bill, but the primary objective is being sure that what works very well today for our members and the communities they serve will continue to work well going forward. We think that’s been well understood and appreciated in the bill.
ND: You talked about how the draft was structured to preserve the 30-year fixed rate mortgage. Do the provisions of the draft go far enough to still allow for other mortgage products like an adjustable-rate mortgage?
WW: I certainly think so. The other products are easier to structure and there’s a deeper investor base for those other products. The 30-year fixed rate is a complex instrument and it does need, for the full market to work, some level of government support. If the 30-year fixed rate works, the other products are going to work well.
ND: Are there provisions in the bill that are setting off red flags for officials or the industries that are going to be most affected? What type of road blocks could stand in the way of this bill moving forward in the Senate?
WW: This is a very broad and ambitious project. Corker-Warner was ambitious and was 120 pages and this is now 440 pages of details around creating, from some places scratch, some different roles in the marketplace. The first question is do all the pieces work together? On the surface of it the majority of the pieces seem very reasonable, and we and others are going through it with a fine tooth comb. The Independent Community Bankers of America (ICBA) has joined with other major groups representing small lenders and has identified a number of concerns about the major elements of the bill. On these issues, which do not directly impact FHLBanks, we will defer to our member trades. I expect these issues will be addressed as the legislation moves forward in the future.
We think that the regulator of the Federal Mortgage Insurance Corporation (FMIC) would have to have some flexibility and be able to make adjustments so that as we learn moving forward, not everything is hardwired. The boundaries of the FMIC’s authority will also get serious attention, as it should.
One of the most difficult things is centered on the politics. There are a number of different perspectives that are hard to put together. You have a group of people that are focused on affordable housing, a group of people that want no government involvement; you have a group of people focused on the scope of a new regulator. It’s going to take a great amount of political skill to pull all of that together and make the bi-partisan dynamics work.
ND: It sounds like the biggest road block may not necessarily be in the content or the details but whether or not Washington has the appetite right before a major midterm election.
WW: We get a sense the politics of getting it done this year are a long shot. We talk about the bill, and you look historically at legislation that has been this ambitious, it generally doesn’t happen overnight. It generally takes a series of Congresses for the concepts to surface, to be put into various legislative alternatives and ultimately for Congress to vote on it. I don’t think it’s surprising that this may take a longer period of time. This process has been beneficial. The ideas that are surfacing today are a lot better than the ideas that were surfacing two years ago. We’re heading in the right direction.
The real value of having a 124-page bill come out as a 440-page bill is that it puts into focus all of these very important details and gives everybody a chance to kick the tires. A group such as the ICBA has spent an incredible amount of time going through all the finer details and is a tremendously effective group in Washington. We’re watching very closely what ICBA’s concerns are because they’re largely going to be our concerns going forward.
ND: Let’s talk more about how community banks are going to be treated in any new mortgage marketplace. Our biggest concern, and I think ICBA’s, is making sure that community banks aren’t being left out and the market isn’t dominated by only the largest Wall Street banks. After hearing from community bankers across the country while drafting this legislation, did the Senators do an adequate job of ensuring community banks have that access to the secondary market?
WW: Certainly it’s an important question for the ICBA and PACB, but I think it’s also an important question for the marketplace. I don’t think anyone wants a market which four entities dominate. The people we’ve talked to, across the board — in Congress, the Administration and trade associations — are really focused on the need for multiple participants and small lenders playing a role.
Small lenders reach parts of the market that aren’t always reached by other financial institutions so it’s very important they have competitive access (to the secondary market). Two examples of how the legislators are trying to solve this issue are the small lender mutuals and the potential role for Federal Home Loan Banks as aggregators for small lenders. The intention to do the right thing by small lenders is there. ICBA in particular is doing a great job to ensure that those issues and interests are well served.
ND: The Federal Home Loan Bank System is a government sponsored entity. How could housing finance reform legislation impact your business model and operations model?
WW: The system as it is today works very well, and the most important thing for us is to ensure that continues. The Federal Home Loan Bank system was the first lender to banks during the crisis. The system performed very well both in terms of providing liquidity to our members and doing it in a safe and sound manner that protected taxpayers as well. We want to preserve that.
The way Johnson-Crapo is written does preserve that business model and the intention is to preserve it. The benefits that we bring, and how the business model delivers them, are well understood by Congress and staff members and we’ve had a great deal of help from PACB and others in telling that story.
With the help of PACB’s members, we are getting our message to the Congress. We are working to assure all of our owners that the business model should be vibrant going forward. The legislation does offer FHLBanks the option of leveraging our experience working with our members to help them originate mortgages as an aggregator. We feel that could be a constructive role for home loan banks and look forward to how that will play out.
ND: The mutual option is strong enough should a community bank choose not to use an aggregator such as a home loan bank?
WW: I think it should be.
ND: Can you talk a little on the impact for either a current homeowner or someone that is looking to purchase a home? Are certain loan options that were available in the past no longer going to be available?
WW: It’s a little too early to tell how or if a homeowner is going to notice any changes. I will say that the mortgage options that are available in today’s marketplace are almost all but certain to be available in any new marketplace. Since the Johnson-Crapo bill reduces the exposure of the Federal government to the risks associated with supporting mortgage credit by putting a first-loss provision for private capital, one would assume that mortgages will be somewhat more expensive in the future, but this may well be offset with the certainty and stability that we hope such legislation will bring to the mortgage markets.
This legislation is very much about getting to a new normal in the mortgage markets as we come off the boom markets fed by unsustainable products to the housing crash to the credit restrictions of the post-crisis corrections. The Johnson-Crapo draft will serve as an important milestone as the Federal Home Loan Bank of Pittsburgh and our members in PACB continue this journey together.