Wednesday Washington Watch
Today Mike Farrell appeared as a panel participant at a House Financial Services Committee entitled The Future of Housing Finance – A Review of Proposals to Address Market Structure and Transition. The comments of each panel participant are available on the committee’s website. We post Mr. Farrell’s comments below.
Chairman Frank, Ranking Member Bachus, and members of the Committee, thank you for the opportunity to speak today on the future of housing finance, a subject that affects virtually every American, and not just homeowners. My name is Michael Farrell, and I run Annaly Capital Management. Annaly is the largest listed residential mortgage REIT on the New York Stock Exchange with a market capitalization of $11 billion. Annaly, together with our subsidiaries and affiliates, owns or manages over $90 billion of primarily Agency and private-label mortgage-backed securities (MBS). Additionally, we also are deeply involved in the mortgage markets through our securitization, structuring, financing, pricing and advisory efforts.
I am here today representing the secondary market investors who have historically provided the majority of the capital to the $11 trillion mortgage market, and my remarks are focused on that perspective. Debate over housing finance reform has largely been about government’s role in it, and rightly so given that Fannie and Freddie’s government-sponsored hybrid charter was ultimately disastrous for taxpayers. However, there are certain activities that these Agencies performed that are important to the pricing and liquidity of the housing and mortgage market.
The current housing finance system, certainly the one that prevailed until underwriting standards started to slip around 2004, is the most efficient credit delivery system the world has ever seen. There are important elements of the existing system that are worth keeping:
· First: securitization, where fully documented borrowers of similar creditworthiness using similar mortgage products are pooled and receive the benefits of scale in pricing.
· Second: the government guarantee to make timely payments of interest and principal on MBS that scales the process even further by making the securities more homogeneous.
· Third: the to-be-announced, or TBA market, which is what Fannie and Freddie and Ginnie facilitate. It is through the TBA market that most residential mortgages are pooled and sold, and it enables originators and investors to hedge themselves.
I believe that the market will adapt to whatever changes occur to these items in a new housing finance system. However, the market will adapt to the new structure by repricing it. If the new system has significantly different risk, uncertainty and friction than the housing finance system we have now, the consequences may be that our housing finance system is smaller with lower housing values and less flexibility and reduced mobility for borrowers. This can have ongoing and broad consequences for economic growth.
If mortgage rates and house prices were not an issue, the government would not have to be involved in housing finance. But these are important issues. Therefore, I believe a housing finance system that utilizes a government guarantee on well-underwritten mortgage securities would maintain the significant size and liquidity of the market, as well as continue to provide for relatively lower costs to the borrower. Going forward, however, the portfolio activities of Fannie and Freddie should be eliminated. The private market would expand its investment activity to fill this role, much like Annaly and its brethren do now. But it is important for the Committee to understand that the majority of Agency MBS investors finance their positions, using financing that is available and priced where it is because of the government guarantee on the assets. Fannie and Freddie financed their portfolio purchases through the capital provided by the debt markets. This is an essential component of housing finance.
In any transition, Congress must consider the potential size of the market in the system to which we are transitioning, because about $8 trillion of the $11 trillion in home mortgage debt is funded by investors in both Agency and private label mortgage-backed securities. Of that $8 trillion, some 70% is held by investors in rate-sensitive Agency MBS, with the balance in credit-sensitive private-label MBS. There isn’t enough capital for the universe of credit-sensitive private-label MBS investors to supplant the installed base of rates buyers, at least not at the current price. Without the support of mortgage values and home prices that is provided by the government guarantee, the funding hole of $8 trillion will get smaller only by shrinking the value of the housing collateral and the mortgages needed to finance them. At its essence, then, any transition to a new housing finance system has to factor in the speed with which these values will change.
In conclusion, I believe that Fannie and Freddie should continue to operate in conservatorship with a goal of winding down their retained portfolios over a set period of time and honoring the guarantees of the Agencies. For simplicity’s sake, and the markets like certainty and simplicity, going forward Congress should consider delivering explicit government guarantees on MBS in a manner similar to Ginnie Mae. This would enable it to continue to serve as the portal between the borrower and the secondary market through securitization and the TBA mechanism, but most importantly enforce underwriting standards for mortgages carrying the government guarantee.
Thank you again for the opportunity to testify today, I look forward to answering your questions.