Mortgage Industry Stakeholders Say PATH Act Has Some Flaws


Representatives of various industry trade groups testified before the House Financial Services Committee last week to provide their feedback on the proposed Protecting American Taxpayers and Homeowners (PATH) Act, a housing finance reform bill introduced in the House of Representatives that would liquidate government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac within five years, replacing them with a securitization platform, and reduce the scope of the Federal Housing Administration (FHA), among other measures.

One of several draft housing finance reform bills wending their way through Congress, the PATH Act was introduced by House Financial Services Committee Chairman Jeb Hensarling, R-Texas, and is backed by Republican leaders of the committee. Viewed largely as the Republican counterproposal to two similar bipartisan bills introduced in the House and Senate, the PATH Act aims to create a sustainable housing finance system by ending the taxpayer-funded bailout of the GSEs, increasing competition in the housing finance market and providing consumers with more mortgage products to choose from.
Unlike the Housing Finance Reform and Taxpayer Protection Act of 2013, a bipartisan bill introduced last month by a group of senators led by Tennessee Republican Bob Corker and Virginia Democrat Mark Warner, the PATH Act does not include any government guarantee for mortgages securitized through the platform. It would guarantee only loans insured by the FHA and similar agencies.

This is in contrast to the Corker-Warner bill, which would replace the GSEs with a government reinsurer and require private secondary market guarantors to hold capital of 10% of the principal of the underlying securities to cover any first losses. In addition, this bill would allow the government reinsurer to cover a greater share of the losses in the event another downturn threatens credit availability.

During Thursday's hearing before the House Financial Services Committee, David H. Stevens, president and CEO of the Mortgage Bankers Association (MBA), said that while the MBA supports the introduction of the PATH Act as a starting point for negotiating reforms, the group has serious concerns regarding some of the bill's measures.
In particular, the MBA has strong concerns with a section of the PATH Act that proposes limiting the scope of the FHA.

‘Each of the policy choices in this bill carries with it the potential of reducing affordable credit options for many otherwise qualified borrowers in the single-family and multifamily markets,’ Stevens said. ‘While we share your goal of reducing FHA's footprint to a more traditional role, we urge the committee to re-examine changes to the single-family mortgage insurance coverage, repurchase requirements and loan limit floor, as well as multifamily income limits. The final bill should strike a balance between strengthening FHA's fiscal solvency and maintaining flexibility to support both homeownership opportunities for first-time and working-class borrowers, as well as a vibrant rental housing market.’

More specifically, the MBA has concerns with a section of the PATH Act that would reduce the FHA's mortgage insurance coverage from 100% to 50% over a period of five years.
‘[The] MBA has serious concerns with the implications of such a significant policy change for the price availability of mortgage credit through the FHA program,’ Stevens said. ‘Even if it were well constructed, such a change could significantly reduce the number of lenders willing to participate in FHA, given the increased risks to the lender. Such a decrease in competition would necessarily reduce lending and increase costs for consumers.

‘Mortgage lenders are accustomed to managing representation and warranty risk but are not structured to take on large amounts of credit risk,’ Stevens added. ‘If they were forced to take on this risk through a reduction in the coverage of FHA insurance, it could potentially cause them to restrict credit or go out of business. Lenders who choose to hold FHA loans as investments would also be disadvantaged. Because of the 100 percent guarantee, FHA-insured loans held in lenders' portfolios receive a 20 percent risk weight. Reducing the FHA guarantee could lead to different accounting and bank capital treatment for holding or servicing FHA-insured loans, further impacting the cost and availability of credit to American home buyers.’

Stevens pointed out that decreasing insurance coverage would require Ginnie Mae, which relies upon a full credit guarantee from the FHA, to increase its guarantee fees. In this regard, ‘reducing FHA's guarantee would simply move risk from one government entity to another,’ he said.

Mark Zandi, chief economist at Moody's Analytics, said the PATH Act's proposal to liquidate the GSEs was ‘comprehensive but ultimately unviable.’ He warned that if the current draft legislation were enacted today, it would lead to significantly higher mortgage rates.
‘Under the kind of system envisaged in the PATH, providing the system with enough capital to withstand a mortgage default loss rate of five percent – about the system's current capitalization level – would drive mortgage rates nearly 90 basis points higher than they currently are today,’ he said.

Zandi pointed out that in order to make the market truly privatized, smaller institutions would have to replace the GSEs' roles. Should some of these smaller lenders fail as the result of an economic downturn, their failure would not threaten the system. However, there is a question as to how much capital they would be able to provide in the form of credit. Should a catastrophic scenario come along that wipes out all of the smaller lenders' capital, the government would have little choice but to intervene in order to keep the housing finance system solvent, he said.

‘The housing finance system needs reform,’ Zandi said. ‘But reform's success depends on striking the appropriate balance between the benefits of the private market and the backstop of the federal government. Finding the right balance will strengthen the housing market, stabilize the financial system and lead to a healthier economy.

‘The PATH as currently written does not find that balance,’ he added. ‘The housing finance system it envisages is largely privatized, providing no government backstop under any economic circumstances. The result will be measurably higher mortgage rates, the marginalization of the 30-year fixed-rate mortgage loan and a less stable housing market. Larger lenders will likely grow larger in the PATH, and disadvantaged households will have less access to affordable housing.’

Jerry Howard, CEO of the National Association of Home Builders (NAHB), also urged the committee to add a provision to the PATH Act to ensure that the federal government continues to provide an explicit backstop, so that the flow of credit is not cut off in the event of another economic downturn.

‘The historical record clearly shows that the private sector is not capable of providing a consistent and adequate supply of housing credit without a federal backstop,’ Howard said.

Similar to the MBA and other groups, the NAHB wants to see the GSEs phased out gradually but with an explicit federal guarantee. However, the NAHB wants a provision stating that the federal government would only intervene once specified levels of private capital and insurance reserves are depleted before any public funds are used.

Like Stevens, Howard said his group also has serious concerns regarding the provisions in the bill that would limit the role of the FHA.

‘The PATH Act would drastically diminish FHA's vital liquidity mission,’ he said. ‘By simultaneously leaving all federal support for housing to FHA and then by greatly reducing the overall scope and reach of FHA's programs, PATH would greatly limit homeownership and rental housing opportunities for many financially responsible and qualified Americans.’

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