Setting the Stage for Sustainable Real Estate Liquidity

Right now the real estate finance market is recovering. However, when the refinance boom, driven by record low rates and extraordinary government intervention, ends, liquidity will diminish and the overall mortgage finance volumes could slow significantly.

Refinance originations are anticipated to decrease nearly 30 percent in 2013 and another 56 percent in 2014 as mortgage rates increase and we shift to a more purchase dominated market.

Additionally, an oversized and outdated federal government role (90% of all loans made today are backed by Fannie Mae, Freddie Mac or the Federal Housing Administration) is holding back a return of private capital in the marketplace.

The move from a mortgage market dominated by the government to one where private capital plays the primary role is a difficult one because any hiccup or misstep in the transition could grind the market to a halt, restricting economic growth and tightening access to affordable mortgage credit even more than what we have already seen.

We need to act now to manage that transition while market conditions are favorable.

Both of the government sponsored enterprises (GSEs) — Fannie Mae and Freddie Mac — have reported large net operating revenues, leading some to wonder whether retaining them is the easiest solution now that the housing market is recovering.

I completely disagree.

The reported profits at the GSEs are the sole result of the capital the US taxpayers have injected into the two companies, unprecedented government intervention in the mortgage markets and the increases of guarantee fees (g-fees) and other price increases mandated by the GSEs’ regulator , the Federal Housing Finance Agency (FHFA) — not to mention a pattern of repurchase demands and indemnifications that is far outside historical norms and is in place only due to the lack of competition from other investors.

There is great consensus among industry leaders, economists and Washington politicos that transitioning Fannie Mae and Freddie Mac out of conservatorship must happen. This week, the American Enterprise Institute assembled a panel to discuss this very topic. All on the panel agreed that Fannie and Freddie monopolize the secondary mortgage marketplace, charging lenders extremely high g-fees that are passed onto consumers and yet are still squeezing out private competition.

There was also broad agreement that the government footprint is too large and with markets stabilizing, now is the time for the return of private capital into the marketplace and that Fannie and Freddie’s outsized role creates unbalance and instability within the financial markets, limiting growth of smaller, private institutions.

That’s great, right? We all agree that transition must happen. Unfortunately, that’s where the agreement ends and the Washington stalemate begins.

Major differences exist from this point forward. How should the GSEs transition? What should the government’s role be in real estate finance? What does the transition end state look like?When should we transition? Should transition begin now or should we wait until there is perfect alignment on an end state? Experience shows that if we wait for perfect alignment, it will never get done.

The bottom line is this: There must be a clear path to transition to a new secondary market structure, one that looks beyond current GSE earnings or conservatorship. But rather than wait for a plan for what that final structure might look like, there are steps we can and must take now while market conditions are optimal to achieve this goal.

First, FHFA must move toward a common security structure for Fannie and Freddie in the TBA market.Second, FHFA can bring more private capital into the mortgage market now by mandating that Fannie and Freddie accept lower guarantee fees for deeper credit enhancements such as private mortgage insurance at deeper attachment points or other risk sharing arrangements.

Finally, FHFA must redirect the GSEs; single securitization platform initiative so that it serves the needs of the broad securitization market of the future, including the GSE's, and this work must be done with the private sector providing guidance and direction.

From an interest rate perspective, the opportunity to capitalize on transition will never be more advantageous than now, while rates are at historic lows and large refinancing volumes are adding to liquidity. Over the next year, rising rates and fading refinances will reduce overall mortgage activity and impair market liquidity. Thus taking action during today’s more liquid conditions is preferable.

Given the path of housing starts and home sales, purchase originations are projected to increase 17.7 percent in 2013 to $592 billion, and another 18.8 percent in 2014 to $703 billion. With the GSE supremacy in today’s housing market, if nothing is done, Fannie and Freddie will continue to edge out private competition. Endless conservatorship is not a sustainable option nor is returning Fannie and Freddie back to their original state. A strong, sustainable secondary market must be built on private capital, with a limited government guarantee to ensure liquidity in all market conditions.

These are just the first steps toward a vibrant, competitive real estate finance system of the future. This plan will lower costs to consumers, boost liquidity in real estate finance and reduce taxpayer risk inherent in today’s market. It requires no Congressional action and can begin right now drawing down the government dominance in the marketplace.

This is the right plan at the right time.