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GSE top guns weigh in on risk sharing

The chief executive officers of Fannie Mae and Freddie Mac weighed in this week in Boston on the debate raging in the mortgage industry over the best ways to transfer risk on loans purchased by the government-sponsored enterprises.

Fannie’s CEO Tim Mayopoulos and Freddie CEO Donald Layton  touted their efforts to offload billions in single-family loan default risk and indicated that they were open to trying new methods, but with caution. The two men appeared Monday at a forum during the Mortgage Bankers Association annual convention in Boston.

PMI(1)The GSEs are mandated by their regulator, the Federal Housing Finance Agency (FHFA), to offload credit risk on new-loan purchases.

Over the past three years, Fannie and Freddie have typically done this by selling off notes to a select few private investors through bond sales after the loans have been purchased and pooled into securities. These are known as ‘back-end” deals. However, some industry groups and private mortgage insurers want to see more front-end risk sharing, where the loan would be partially 'de-risked' before the GSEs purchase the loans. The FHFA  recently sought input on front-end structures. The leading candidate for this would be a major expansion of the role of private insurers. 

Layton said he was “agnostic” about the best methods. He predicted that within 10 years, the GSEs would have developed five or six standard methods to transfer risk.

“For the rest, let the best one win,” Layton said."It's time to compete. It is the time to test and learn." 

The CEOs said that any new structures should not add complexity to the origination process, and should truly transfer the risk away from taxpayers. Critics of front-end risk sharing, such as the American Bankers Association, are concerned that loans with a front-end risk sharing component will become harder and more expensive to originate. Back-end deals don’t affect the origination process, and lenders are unaffected by these deals. Small lender groups are also suspicious of front-end deals, fearing that big banks will gain back an advantage in pricing. 

Some groups are also skeptical that private insurers would be able to cover the losses in a major downturn, so the GSEs would wind up liable for the losses to investors in the mortgage-backed securities.

Mayopoulos cautioned that it was unclear if the GSEs could continue to transfer risk at the same pace during market downturns. Mayopoulos noted that the GSEs have transferred more than $44 billion in risk since 2013.

"This is happening on a very big scale," Mayopoulos said. "I would agree with Don that I don't believe we have anywhere exhausted all the possibilities here. This is a place where innovation will occur, should occur." 

 In a speech beforehand, FHFA Director Mel Watt said the government is going to require the GSEs to expand financing for affordable housing. Watt only briefly mentioned risk sharing, and did not tip his hand on whether the GSEs will be required to do additional front-end pilots.   


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