While still on the agenda, Treasury Secretary Steven Mnuchin recently admitted that this Congress is not likely to enact GSE reform. GSEs recently took initiative to create Credit Risk Transfer securities (CRTs) — which continue current federal guarantees against mortgage defaults, but transfers from taxpayers to investors much of the risk of such guarantees.
Robert Pozen and Clayton Pfannenstiel recommend these changes to the tax structure. First, the GSEs should increase the amount of default risk transferred to investors, and second, the guarantee fees charged by the GSEs to mortgage originators should be based on the fees paid on CRTs to investors. They explain:
Here is a brief summary of CRTs. The GSEs buy mortgages from banks and brokers, and then sell interests in pools of these mortgages as mortgage-backed securities (MBS). The default risk on their MBS is guaranteed by the GSEs, so MBS holders are fully protected from shortfalls in principal or interest payments. But the GSEs will take big losses if the U.S. goes through another period of widespread mortgage defaults. To mitigate this risk, the GSEs designate some of the mortgages underlying their MBS to serve as a reference pool for the CRTs. The performance of the CRTs depends on the default rate experienced by these designated mortgages. In effect, the GSEs are paying investors a premium to reinsure a large part of the government guarantees against default risk on their MBS.
The CRTs are divided into several tranches to appeal to investors with different risk appetites. For example, hedge funds tend to buy the lowest-rated tranche with the highest yield, but it is allocated the first losses on these mortgages. Mutual funds tend to buy the highest-rated tranche, which has the lowest yield but which is last in line for losses. Despite the success of the CRT programs to date, we believe the GSEs should expand the amount of risk transferred to private investors through these securities. CRTs are designed to transfer enough risk to cover mortgage losses incurred during the 2008 financial crisis, roughly 4% of unpaid principal, after adjusting for the improved quality of the current GSE mortgage portfolio (source: Data Dynamics).
We believe that the regulator should promptly lower the fees charged by GSEs to mortgage originators, as implied by CRT pricing. Those fees should decline further in 2021 when the GSEs will no longer be required to pay a temporary remittance mandated by Congress in 2011. Lower GSE fees to mortgage originators would lower the cost of many home mortgages, thereby helping borrowers with low- and moderate incomes.
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