Pursuant to the Presidential Memorandum Issued March 27, …

[Pages:43]Housing Finance Reform Plan

Pursuant to the Presidential Memorandum Issued March 27, 2019

September 2019

Contents Executive Summary ................................................................................................................... 1 Introduction................................................................................................................................ 4

A. FHA Background ..................................................................................................... 5 B. GNMA Background ................................................................................................. 6 I. Refocus FHA to its Core Mission ................................................................................... 8 A. Targeting Programs to Borrowers Not Served by Traditional Underwriting........... 8 B. Define Roles for Government-Supported Programs Through Better Coordination12 C. Strengthening FHA Single-Family Default Servicing Processes ........................... 13 D. Ensure HUD's Multifamily Programs are Appropriately Targeted ....................... 15 E. Provide Regulatory Certainty to FHA Lenders ...................................................... 16 II. Protect American Taxpayers........................................................................................ 18 A. Strengthen FHA Risk Management Systems and Governance .............................. 18 B. Improve Financial Viability of the Home Equity Conversion Mortgage Program 19 C. Implement Tiered Pricing to Protect the MMIF..................................................... 20 D. Eliminating Regulatory Barriers to Affordable Housing Including Manufactured

Housing .................................................................................................................. 20 III. Provide FHA and GNMA the Tools to Appropriately Manage Risk ....................... 23

A. Establish FHA as an Autonomous Corporation within HUD ................................ 23 B. Hire and Retain the Right Talent to Mitigate Risks to Taxpayers ......................... 23 C. Align Contracting and Procurement Processes with Business Needs .................... 23 D. Modernize FHA Technology.................................................................................. 24 E. Realign Housing Assistance Programs into a New Office of Rental Subsidy and

Asset Oversight within HUD ................................................................................. 25 IV. Provide Liquidity to the Housing Finance System ..................................................... 27

A. Advance GNMA Counterparty Risk Management and Securitization Platform Transformation ....................................................................................................... 28

B. Guaranty Fee-setting Flexibility............................................................................. 29 C. Reforms to Maintain the Integrity of GNMA Securities........................................ 30 Conclusion ................................................................................................................................ 31 Appendix A ................................................................................................................................... I

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Executive Summary

1. Refocus FHA to its Core Mission

The financial crisis resulted in private capital receding from the housing finance system. As a result of the crisis and subsequent policy decisions of the previous Administration, the market share of the Federal Housing Administration's (FHA) increased dramatically from pre-crisis levels. As the United States Department of Housing and Urban Development (HUD) pursues reforms, FHA should refocus on its mission of providing housing finance support to low- and moderate-income families that cannot be fulfilled through traditional underwriting, including targeting first-time and lower-wealth creditworthy homebuyers who benefit from FHA's ability to provide affordable mortgage credit at fixed rates with lower down payments.

Since the financial crisis, the risk profile of FHA's portfolio has increased steadily, endangering FHA's ability to support access to affordable mortgage credit for first-time homebuyers (FTHBs). Credit scores of borrowers have fallen, while loan-to-value (LTV) and debt-to-income (DTI) ratios have increased. The use of downpayment assistance (DPA) programs also has grown significantly. Further, FHA's activities have strayed away from its core mission--through July of FY2019, 70 percent of FHA refinance endorsements are cash-out refinancing and FHA remains the largest insurer of reverse mortgage products through its Home Equity Conversion Mortgage (HECM) program. These activities create risks to the solvency of FHA and interfere with its core mission of helping low- and moderate-income borrowers with good credit ? yet limited assets ? afford a home and build wealth.

Through a formalized collaborative approach, FHA and the Federal Housing Finance Agency (FHFA) must work together to ensure that government-supported mortgage programs are not competing and do not crowd private capital out of the marketplace, both in their Single Family and Multifamily programs. Further, FHA must ensure that borrowers are creditworthy and that they have access to loans that meet their financial needs without creating undue risk. A mortgage product that is inappropriate for a borrower may lead to default and foreclosure, destroy credit, and exacerbate affordable housing need.

FHA must continue to have a strong enforcement regime that appropriately punishes bad actors and those who willingly defraud taxpayers. However, its enforcement regime should not deter reputable and well-regulated lenders from participating in FHA's programs. Accordingly, it must provide clarity and transparency in its regulatory expectations for participating lenders, including addressing lender and loan-level certification standards and the defect taxonomy. In collaboration with the Department of Justice (DOJ), FHA should continue to work to provide more clarity on how the agencies will consult on the appropriate use of the False Claims Act (FCA), which has driven away many lenders, including many depository institutions, from the FHA program. FHA must ensure it continues to appropriately use all enforcement remedies and mechanisms available. Doing so will provide lenders with transparency and a higher level of certainty and promote the participation of a more diverse lender base in FHA's programs.

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2. Protect American Taxpayers

With mortgage insurance on loans of over $1.4 trillion in unpaid principal balance (UPB) and more than $2.1 trillion in mortgage-backed securities (MBS) guaranteed by the full faith and credit of the United States, FHA and the Government National Mortgage Association (GNMA), respectively, must ensure their business and operational practices protect American taxpayers. Meeting this duty also is essential to FHA's and GNMA's respective missions and if either does not operate in a fiscally responsible manner, HUD's ability to provide affordable and sustainable mortgage credit for borrowers is severely jeopardized. FHA must maintain an appropriate level of capital reserves in the Mutual Mortgage Insurance Fund (MMIF). It is unacceptable for FHA to require a draw on taxpayer funds to sustain its book of business and so FHA should seek to build its capital ratio well above the statutory two percent minimum to ensure that it is able to weather stress events without requiring a taxpayer bailout.

FHA's risk management capabilities must be improved in order to prudently serve its core mission and to protect taxpayers. In particular, FHA must transform its data analytics and risk management capabilities. FHA also must continue to develop policies that ensure its reverse mortgage product ? HECM, which has cost the MMIF billions of dollars in claims in recent years ? is fiscally sustainable. To ensure that HUD and taxpayers are properly compensated for riskier loans, FHA should implement a "tiered pricing" framework to protect the MMIF.

FHA and GNMA must ensure that they can properly manage their counterparty risk exposure and strengthen surveillance practices. To achieve this strategic aim, FHA and GNMA should continue to work with FHFA and other federal entities to institute a framework that allows for ongoing coordination and evaluation of housing finance policies to ensure proper alignment across taxpayer-supported segments of the nation's housing finance system. GNMA must also evaluate its counterparties and their ability to withstand the stress inherent to changing conditions in the financial markets.

3. Provide FHA and GNMA the Tools to Appropriately Manage Risk

FHA's and GNMA's respective footprints have increased significantly over the last decade-- FHA has become the world's largest insurer of mortgages, insuring over $1.4 trillion of mortgage loans on single-family homes, multifamily properties, and healthcare facilities. The experience of the financial crisis exposed the importance of improving the operational capabilities of FHA and GNMA and their critical need to have some autonomy and greater flexibility in hiring and procurement.

Today, FHA relies upon 40-year-old technology requirements that inhibit responsiveness to sudden market changes. To modernize FHA, Congress should re-charter it as an autonomous government corporation within HUD, which would provide the agency tools and resources necessary to make appropriate risk decisions to respond to changing markets. It is crucial FHA and GNMA have the appropriate tools to manage risk and both agencies must be given resources to hire and compensate talent with specialized expertise in the mortgage finance, risk management, and MBS markets. These reforms will help FHA prevent foreclosures and minimize risk of a taxpayer bailout in times of economic stress in the housing market.

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4. Provide Liquidity to the Housing Finance System GNMA securitization helps provide liquidity in the mortgage credit market to support the objectives of FHA, the United States Department of Agriculture (USDA), and the United States Department of Veterans Affairs (VA) mortgage insurance programs. During the last 10 years, the size of the GNMA guaranty program has increased in size from less than $500 billion in 2008 to almost $2.1 trillion today. Currently, GNMA's technology platform is secure and robust. As outlined in the U.S. Department of the Treasury's housing finance reform plan, if Congress should authorize it, GNMA could provide an explicit, paid-for guaranty of the timely payment of principal and interest on qualifying MBS that are guaranteed by the GSEs and any potential competitor guarantors that might be chartered by FHFA. In recognition of its increased size and a potential expansion of its role, GNMA must also ensure that program participation requirements mitigate risk to the Federal Government. In support of this goal, GNMA must use its authorities to end lender practices, such as loan "churning," that increase the cost of mortgage credit for borrowers utilizing FHA, USDA, and VA mortgage insurance.

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Introduction

In the wake of the financial crisis, the dream of homeownership receded for many Americans. Today, however, lower taxes and the elimination of unnecessary government regulations have created an economic renaissance, making homeownership less of a dream and more of a possibility. As a direct result of the Trump Administration's pro-growth policies, unemployment is at a 50-year low,1 and American families are earning higher incomes and enjoying more opportunities than seemed possible just a few years ago.

Yet, there is still one piece of unfinished business from the 2007-2008 financial crisis: housing finance reform. Due to government policies that encouraged risky lending and created moral hazard by building expectations that the Federal Government would bail out failing firms, the housing finance system was a central cause of the financial crisis. This system must be reformed and it is long overdue.

HUD plays a critical role in the nation's housing finance system--FHA provides credit enhancement and regulatory oversight for a portfolio exceeding $1.4 trillion and GNMA guarantees more than $2 trillion in MBS, with the full faith and credit of the United States of America. The symbiosis between the government-insured mortgage programs at FHA, the USDA, and the VA ? with GNMA-guaranteed MBS ? contributes to lower-cost mortgage credit and more affordable homeownership opportunities for creditworthy American borrowers.

As recognized in the March 27, 2019 Presidential Memorandum on Federal Housing Finance Reform (Presidential Memorandum), HUD plays an integral role in the nation's housing finance system. During the financial crisis, and after due to the policies of the previous Administration, FHA's and GNMA's balance sheets swelled, growing by approximately 350 percent and 400 percent, respectively, between FY2007 and FY2018. While FHA and GNMA are designed to be countercyclical, their balance sheets remain at substantially elevated levels and expose taxpayers to significant risks. In the event of a potential downturn in the housing market, FHA and GNMA may incur serious losses, inhibiting their ability to support the housing market and increasing the likelihood of a taxpayer-funded bailout. When the mortgage market contracts and private capital recedes, HUD must maintain stability in the nation's housing finance system by continuing to serve as a countercyclical buffer. When the economy is strong and markets are well-functioning, HUD must avoid competing with other government-supported programs and private capital, and take steps to provide housing finance support to low- and moderate-income families that cannot be fulfilled through traditional underwriting.

Accordingly, now is the time to refocus FHA and GNMA to their core missions and make sure they have the tools needed to manage their significant portfolios. Both organizations face challenges, including FHA's legacy information technology (IT) platforms and processes, the need for enhanced data analytics to support enhanced risk management, and perhaps most importantly, critical limitations on the ability to innovate and decisively react to changing market conditions to prevent taxpayer losses.

1 Bureau of Labor Statistics, April 2019 Household Survey (Apr. 2019),

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Reform will reduce the Federal Government's outsized role in housing finance and prevent its activities from crowding out the private sector. Consistent with the goals set forth in the Presidential Memorandum, this plan presents a unique opportunity to define an appropriate role for HUD that refocuses FHA and GNMA on their core missions. By doing so, FHA and GNMA will be better positioned to help low- and moderate-income families become sustainable homeowners, build equity and wealth, and enable FHA and GNMA to act in a countercyclical manner in the event there is an economic downturn without the risk of a taxpayer-funded bailout.

A. FHA Background

FHA's origin traces back to the Great Depression when Congress authorized its creation under the National Housing Act of 1934. The FHA of the 1930s served the same primary function as it does today: providing insurance coverage against losses on mortgages originated by FHAapproved lenders. Then, as in subsequent periods of market distress, FHA's mortgage insurance program has provided stability to the housing market and increased capital liquidity for home buying and construction.

FHA mortgage insurance eliminates the need for lenders to charge additional risk premiums. The reduction in risk allows lenders to offer affordable mortgage credit, expanding homeownership to low- and moderate-income families that cannot be fulfilled through traditional underwriting. FHA particularly benefits low- and moderate-income and FTHBs who may have good credit and income sufficient to support a mortgage, but not the assets to cover more than FHA's 3.5 percent minimum down payment requirement. In return for the benefits of mortgage insurance coverage, borrowers pay mortgage insurance premiums. FHA must generate enough premium revenue (and interest thereon) to cover expected losses and maintain the minimum capital reserve ratio of two percent required by statute.

During the financial crisis, FHA served as a countercyclical buffer in the nation's mortgage finance system by expanding to support the stability of the housing market during and after the financial crisis. When private capital largely withdrew from the housing finance system, FHA's share of mortgages for home purchase (as opposed to refinance mortgages) expanded to a peak of nearly 30 percent. FHA's single-family housing portfolio grew considerably in the wake of the financial crisis, reaching a high of 1,831,234 endorsements in FY2009 and remains at an elevated level. FHA endorsed 1,014,583 loans in FY2018. Today, FHA insures over 8.1 million forward and nearly 500,000 reverse single-family mortgages with more than $1.2 trillion in UPB. When FHA's multifamily and healthcare programs are included, the total UPB is $1.425 trillion.

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Figure 1

While FHA was created to counter the collapse of the housing finance market during the Great Depression, its mission now includes the promotion of affordable housing opportunities and homeownership, specifically for buyers not served by traditional underwriting. Then, as now, FHA facilitated access to credit for borrowers from lenders and also increased investor confidence to purchase mortgages.

B. GNMA Background

Since 1968, when Congress authorized the creation of the agency, GNMA has played a central role in the development of the U.S. mortgage securitization system. Then, as now, GNMA effectuates its mission by providing a full faith and credit of the United States guaranty of the timely payment of principal and interest to security holders of MBS backed by pools of mortgages insured or guaranteed by federal agencies, including FHA, VA, and USDA. GNMA does not originate mortgages and does not issue MBS--it relies on issuers that are approved financial institutions to pool or securitize eligible mortgages, either originated or acquired by the issuers to issue GNMA-guaranteed MBS. The GNMA MBS guaranty program supports singlefamily forward residential mortgages, single-family reverse mortgages through the Home Equity Conversion Mortgage MBS (HMBS) program, and mortgages secured by multifamily and healthcare properties, and manufactured housing.

Following the financial crisis, GNMA's outstanding MBS portfolio has increased nearly fourfold to over $2.1 trillion concurrent with growth in the combined mortgage insurance and guaranty programs of FHA and VA. The market was able to absorb this substantial growth, which has been supported through investor demand for alternative full faith and credit instruments (i.e., U.S. Treasuries). The "last position" guaranty in mortgage securitization that GNMA covers in

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