Farrell Testimony to Congress: US Housing Finance System

[scandal 951]

I found this commentary fascinating. In particular, he points out the key ways in which the US housing market is unique. And, the risk of abandoning the GSEs (Fannie and Freddie) and expecting private agencies to take over that role entirely.

Testimony of

Michael A.J. Farrell

Chairman, Chief Executive Officer and President

Annaly Capital Management, Inc.

Before the

U.S. House of Representatives

International Monetary Policy and Trade Subcommittee

of the Committee on Financial Services

Hearing on

"The U.S. Housing Finance System in Global Context: Structure, Capital Sources,

and Housing Dynamics"

October 13, 2011

Washington, DC

Good morning, my name is Michael Farrell, and I am the CEO of Annaly Capital Management, the largest

residential mortgage Real Estate Investment Trust (or REIT) in the country. Through Annaly and our

subsidiaries and affiliates we own or manage a wide range of mortgages and other real‐estate related

assets, including Agency and non‐Agency residential mortgage‐backed securities (or MBS).

I represent the mortgage REITs and other secondary mortgage market investors who provide the

majority of the capital to finance America’s homes. Through our MBS holdings my company and its

affiliates alone are responsible for funding almost a million American households.

At this point in history, while our nation’s banks have about $13 trillion in total assets, the amount of

mortgage debt outstanding totals about $10.5 trillion. There isn’t enough capacity in our banking

system to hold the outstanding mortgage debt, and as a result about two‐thirds of that total, or $6.8

trillion, is held in securitizations‐‐$5.5 trillion in Agency mortgage‐backed securities and the balance in

private label mortgage‐backed securities. The American mortgage finance system needs to have

effective long‐term holders of mortgage credit outside of the banking system. It is thus axiomatic that

without a healthy securitization market our housing finance system would have to undergo a radical

transformation.

Some have argued that this should not be a problem because other countries have similar homeownership

rates and manageable mortgage costs. These arguments miss some very significant points.

First, the US mortgage market is unique. In the US, securitization is the largest mortgage funder with

banks a distant second, while Europe is almost the exact opposite, with about two‐thirds of mortgages

funded by bank deposits, covered bonds a distant second and very little securitization. So the European

model is largely dependent on the deposits and individual credit ratings of European banks. As proof,

consider that in the US, bank assets total about 80% of GDP, while in Canada, Denmark, France,

Germany and Spain bank assets are anywhere from two to four times GDP. Moreover, most mortgages

in other countries are recourse to the borrower, shorter‐term, prepayable only with a penalty and

variable‐rate, which makes it a much different product than the typical American mortgage, with much

different risks for the borrower and the lender.

Second, our current housing finance system is the most efficient credit delivery system in the world.

Securitization allows borrowers of similar creditworthiness using similar mortgage products to receive

the benefits of scale in pricing. In addition, the government guarantee to make timely payments of

interest and principal on a large portion of these mortgages scales the process even further. The TBA, or

to‐be‐announced market, is the window through which much of this scale occurs; it maintains a

consistent underwriting standard, levels the playing field for smaller loan originators and community

banks and enables lenders to offer longer rate‐locks to borrowers. It is an important tool for making

possible the availability of the very popular 30‐year fixed‐rate, prepayable, mortgage with a manageable

down payment for a wide swath of creditworthy borrowers.

Third, unlike the smaller, domestically financed housing markets of other countries, our system attracts

a much broader investor base for residential mortgages, including institutional investors here and

around the world. These investors include US and foreign banks, central banks and sovereign wealth

funds, mutual funds, state and local governments and the GSEs themselves. According to Freddie Mac,

foreign investors constitute the third largest single holder of Agency MBS. What attracts these investors

to fund US residential mortgages? It is the size, scale and flexibility of the Agency MBS market, its

homogeneity, liquidity, ease of pricing and, importantly, their capital risk‐weightings.

Finally, I want to get to the heart of the current debate: Can the private label MBS market come back to

fill the credit gap that is currently filled by the GSEs? The short answer is: Not at the same level of

mortgage rates and not in the same size. Many, if not most investors in Agency MBS won’t invest in

private label MBS at any price or only in reduced amounts because of their need for liquidity or the

restrictions of their investment guidelines. Some of these so‐called “rates investors” could cross over,

and investors in other asset classes might be attracted to a deeper private label MBS market, but we

can’t say for sure how many or at what price or in what time frame. Analysts at Credit Suisse have

estimated that US housing could lose roughly $3 to $4 trillion in funding from domestic and foreign

investors if Agency MBS were replaced by credit‐sensitive products. The impact of this loss could have

adverse consequences for the housing market and the economy for years to come.

In conclusion, the American mortgage market and the sources of funding for America’s mortgages are

unique. The domestic and global investors who provide so much capital to buy American homes will

adapt to whatever Congress decides to do with housing finance policy, but they may adapt by not

investing at all. I believe that a housing finance system that does not include the homogeneity and

liquidity made possible by government involvement will be smaller and more expensive, with potentially

negative consequences for home prices and homeowner flexibility.

I welcome any questions you may have.

# # # #

[scandal 951]

Paul Volcker weighs in.

Volcker: Discard Fannie, Freddie, But Not Yet

Tuesday, 25 Oct 2011 08:27 AM

By Dan Weil

The government-sponsored mortgage agencies Fannie Mae and Freddie Mac should ultimately be discarded, says former Federal Reserve Chairman Paul Volcker.

While Fannie and Freddie can’t be eliminated yet because that would destabilize the housing market, the government needs to ultimately get out of that market, he said in a recent speech and interview with The New York Times.

“We simply should not countenance a residential mortgage market, the largest part of our capital market, dominated by so-called government-sponsored enterprises,” Volcker said in the speech.

“It is important that planning proceed now on the assumption that government-sponsored enterprises will no longer be a part of the structure of the market,” he said.

“This is an opportunity to get rid of institutions that shouldn’t exist,” Volcker tells The Times. “You ought to be either public or private. Don’t mix up private profit-making opportunities with an institution that is going to be protected by the government but not controlled by it.”