July 6, 2017
The American Enterprise Institute: Housing Finance Reform – Remarks by Federal Reserve Governor Jay Powell
- Jay Powell, Board of Governors of the Federal Reserve System
- Stephen Oliner, Resident Scholar and Codirector of AEI’s International Center on Housing Risk
Governor Powell’s Remarks
Governor Jay Powell opened his remarks by describing the “urgent need for fundamental reform” of the housing finance system, calling this the “great unfinished business” of post-crisis financial reform. Powell provided an overview of the current state of the housing finance system, with a highly concentrated securitization market and a widely provided government guarantee for investors in mortgage-backed securities (MBS) that leaves taxpayers with liability and systemic risk.
Powell then described the development of the pre-crisis system, from the creation of the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, their eventual dominance of the housing finance system, the spread of alt-A and no-doc loans in the 2000s, and the collapse of the housing finance system in 2007-2008. Powell also discussed the issues that the implicit government guarantee created.
Powell then discussed how the Housing and Economic Recovery Act (HERA) of 2008 and regulator- led actions, such as the creation of a market for credit risk transfer (CRT), the creation of a common securitization platform (CSP) and the Ability-to-Repay (ATR) and Qualified Mortgage (QM)rules improved liquidity in MBS markets and improved the soundness of the mortgages underlying MBS.
Turning to what a future housing finance system might look like, Powell said it is important that any reform package ensure that mortgage credit is available to as broad a credit box as possible, and that new standards, such as the QM rule, ensure that the loans made have low credit risk. Powell also said that prudential regulation for banks could provide some guideposts for restructuring the GSEs, specifically noting the improvement in stability created by higher capital levels, stress tests, and living wills. Powell also said that private capital could come from a variety of sources, but that any system should have an ample amount in loss-taking positions to protect taxpayers. Powell also noted that the GSEs have been unable to offload any of their catastrophic risk to private sources.
Powell closed his remarks by outlining five principles for reform, which were:
- Any housing finance reform package should reduce or eliminate the possibility of future bailouts. Powell noted that drawing private capital in to absorb credit risk could help accomplish this.
- If there is a government guarantee to backstop the mortgage market, this guarantee should be “explicit and transparent” and a guarantee for securities only, not for institutions.
- There should be more competition in securitization
- Any reform plan should try to reform and repurpose existing regulatory and market infrastructure as much as possible, to avoid having to build new agencies and programs. This will also make any transition less jarring.
- Congress should build on areas of bipartisan agreement and take the “best feasible plan” instead of holding out for a “perfect deal.”
Question and Answer
Oliner began the discussion by asking Powell why Congress and regulators should pursue housing finance reform now. Powell said that the GSE’s oversized role in the securitization of mortgages creates a financial stability issue, which should be dealt with while the economy and the housing sector are relatively strong and stable. Powell also said that continued conservatorship was an untenable option that the timing seems favorable for a new housing finance legislative package. Powell said it is important to act before the memory of 2007-2008 fades, which could discourage future action.
Oliner then asked Powell for his thoughts on the role of the Federal Reserve in reforming the housing finance system. Powell said that the Federal Reserve’s staff resources could help craft the details of policy, and that the central bank could provide insights on creating stability in the MBS market.
An audience member asked Powell to explain why a security-level guarantee is better than an entity-level guarantee. Powell said it is important that any government guarantee for catastrophic risk be as narrow as possible, and that a security-level guarantee will protect investors from major credit risks, while keeping the government out of the business of saving individual institutions.
Powell closed his remarks by praising recent Senate Banking Committee hearings on reforming the housing finance sector and the bipartisan approach that is being taken in that chamber on the subject. Powell noted that many of the plans in circulation today have broad agreement on involving private capital, among other similarities, and was optimistic that the emerging consensus could lead to reform.