Common Securitization Solutions (CSS), the forgotten and most important GSE for Housing Finance Reform

An Open Letter to Policy Makers and Advocates

Summary

Should conservatorship of Fannie Mae (FNMA) and Freddie Mac (FHLMC) occur without proper regard to CSS the housing finance market could see massive operational disruptions.  In this letter a solution for CSS will be offered fortifying the resilience of the housing finance market with or without an exit from conservatorship, increase competition in housing finance, improve transparency in the governance of housing finance, encourage more private capital participation in housing finance, and modernize housing finance for current government guaranteed programs, all while reducing costs to the industry and lowering loan rates on American homeowners.

Background

CSS is jointly owned by FNMA and FHLMC.  CSS’s purpose is to serve as the backbone of the Residential Mortgage Backed Securities (MBS) market that FNMA & FHLMC rely upon for normal operations.  In February 2023 the Office of Inspector General (OIG) of the Federal Housing Finance Agency (FHFA) issued a white paper, attached herein, with a high-level overview of CSS’s operations and how integral of a part of FNMA and FHLMC’s operation CSS plays.  With more than 70% of the MBS market under the custody of CSS, should FNMA and FHLMC be privatized, a risk exists that CSS could be classified as a monopoly over the MBS market, the second largest debt market in the US.  Any attempted break up of CSS would result in significant disruption to the MBS market likely resulting in higher loan rates for American families buying homes.

Solution

The original vision for CSS should be realized and CSS should be a “Public Utility” for the issuance and management of the MBS market.

The debate, releasing FNMA and FHLMC from conservatorship has persisted for over a decade.  There are many opinions on this release.  What is agreed upon the American People cannot afford for the housing finance market to be greatly disrupted.  A thoughtful approach to CSS will prevent market disruption.

Realizing the original vision for CSS as a “Public Utility” eliminates the risks of an artificial break up due to monopolistic concerns.  America has a long history of “Public Utility” monopolies that work well for the people when appropriately regulated.  This is the position this letter takes and calls for CSS to be owned as a public non-profit organization regulated by FHFA.  CSS’s role as ultimate issuer and record keeper of the MBS market makes it a unique use case to serve in the role as the MBS “Public Utility.”  In this role CSS will be able to create consistency of data across the broad MBS market, custodian changes to markets and information, make risks readily identifiable, add more market participants as originators and investors, all while reducing costs and overhead across the industry resulting in lower loan rates for American home owners.

CSS’s transition to a “Public Utility” with or without an exit from conservatorship by FNMA and FHLMC ultimately makes the conservatorship debate simpler by having already addressed any issues of liquidity and market disruptions.  Thought leaders on “GSE Reform” debate implicit and explicit guarantees on the resulting MBS, this result will be important to the MBS market and will impact borrower rates, however with CSS having already been split from FNMA and FHLMC there would be no market operational risk regardless the outcome.

As a “Public Utility” CSS is in the best position to simplify and enhance the efficiency of the MBS market.  Today Ginnie Mae (GNMA), as a department of HUD, operates a separate MBS issuance program that is significantly dated.  GNMA would be able to migrate their MBS operations to CSS allowing GNMA to modernize their programs making GNMA issuance more fungible with FNMA and FHLMC.  The ultimate outcome would be easier processes for GNMA, Lenders, and Investors resulting in enhanced liquidity for GNMA’s securities helping lower loan rates to American homebuyers.

In the same way CSS can drive better results for GNMA with the proper authorizations CSS would be able to create MBS for the Federal Home Loan Bank (FHLB) system.  This letter will focus on the program from Chicago, the Mortgage Partnership Finance (MPF) program.  Currently, participating FHLBs hold mortgage loans originated by Participating Financial Institutions (PFIs) on their balance sheets.  If allowed CSS could work with FHLB Chicago to provide a path for MPF loans to become MBS, freeing up the FHLBs’ balance sheets and moving interest rate risk to the market from the FHLB system.  The MPF program differs significantly from FNMA and FHLMC in how credit risk is managed.  While all programs underwrite the loans substantially the same, FNMA and FHLMC charge Loan Level Price Adjustments (LLPAs) to offset credit risk.  These LLPAs result in higher borrower rates since lenders must charge higher interest rates to make up for the LLPAs charged.  The MPF program has no LLPAs instead the PFIs provide a collateralized guarantee on the pool of loans sold to the FHLBs through the program.  These PFI guarantees provide a significant layer of credit support to the FHLBs’ over and above the value of the houses financed and any mortgage insurance that may be required, see FDIC’s Affordable Mortgage Lending guide pg 39 & 40 attached for more details.  The result has been very limited losses to the FHLBs.  With no LLPAs often the MPF program has similar or lower rates for homeowners in spite of the FHLBs having to use inferior funding mechanisms than securitization.  Allowing the MPF program to be funded by securitization will create additional competition in the housing finance market lowering loan rates on American homeowners, increase competition, and ultimately reduce risks to FNMA and FHLMC.

CSS as a “Public Utility” also would have the opportunity to serve as the backbone for the return of private capital to the MBS market.  Since the SEC adopted Regulation AB II there have been no publicly issued Private Label or non-agency MBS (PLS).  The PLS market has received a large amount of blame for the housing meltdown post 2008.  While a lot of this is warranted what didn’t exist prior to 2008 was a “Public Utility” for the issuance of MBS and by extension PLS.  With some adjustments to Reg AB II and CSS serving as the conduit, CSS and FHFA as its regulator will be able to eliminate the non-credit related risks that plagued PLS in the era just before and after 2008.  Additionally, by allowing CSS to work with organizations that are financially and operationally qualified to participate in the PLS market the non-agency mortgage origination market becomes more competitive.  Today only a few firms can participate in the private placement (rule 144a) market and liquidity is limited therefore requiring higher rates.  By returning to the publicly traded space, adding liquidity and additional qualified market participants the result will be lower loan rates on American homeowners thru increased competition and more efficient markets.  

Conclusion

CSS as a separate “Public Utility” as part of the broader reforms of FNMA and FHLMC will increase competition, improve market liquidity, drive efficiency in the market, add more transparency to PLS, and bring a level playing field to market participants resulting in lower loan rates for American homeowners and reducing risks to housing finance overall.