IT'S BEEN THREE YEARS since Fannie Mae and Freddie Mac were commandeered by the federal government, three long and tumultuous years of operating in limbo.

But even before they were seized, the government-sponsored enterprises (GSEs) inhabited a unique middle space in the American economy—private companies with a public mission, chartered and regulated by acts of Congress but driven by shareholder returns.

It was precisely this model—where profits were privatized and losses were ultimately socialized—that led to their downfall. And now Congress will start again from scratch, sifting through the ashes to remake our nation's housing fi- nance system.

This time will be different, they vow, this time they'll get it right.

Yet, so far, the housing finance reform debate has been a nonstarter, a tale of sound and fury signifying little other than political posturing.

There are more than 20 bills floating around the House of Representatives that in some way address Fannie Mae, Freddie Mac, and housing finance reform. Only one of those bills, the Covered Bond Act of 2011, has made it out of the House Financial Services Committee. And only a couple bills, such as the Housing Finance Reform Act of 2011 introduced by Rep. John Campbell (R-Calif.) and Rep. Gary Peters (D-Mich.), offer a comprehensive solution.

“You've got a lot of action and activity, but nothing really happening,” says Doug Bibby, president of the National Multi Housing Council. “My prediction is that nothing legislatively is going to happen until after the 2012 election."

As a starting point for the debate, the Obama administration released a white paper on housing finance reform in February. The report laid out three possible solutions: a fully private market (Option 1); a private market with an emergency government guarantee in times of crisis (Option 2); and an always-on guarantee (Option 3).

The Campbell-Peters bill mirrors the third option by creating private organizations that would access a government guarantee for mortgage-backed securities. But centrist, bipartisan bills have little chance of advancing in today's House Financial Services Committee, where the power lies with smallgovernment Republicans intent on simply shutting the GSEs down.

The piecemeal legislative attempt emanating from Rep. Scott Garrett's (R-N.J.) Subcommittee on Capital Markets and Government Sponsored Enterprises “is death by a thousand cuts,” says Michael Berman, chairman of the Mortgage Bankers Association (MBA). “They're basically trying to rein in Fannie and Freddie and eliminate them as quickly as possible. What they fail to envision is what would replace them.” (See “Death by a Thousand Cuts" below).

Guaranteed contention

The biggest bone of contention—the centerpiece of the debate—is the degree to which the government should be involved in our nation's housing finance system.

Conservatives say the government has no place in the market and believe the private sector can pick up anything the Federal Housing Administration (FHA) can't handle. Liberals believe a government guarantee is desperately needed, that the affordable housing debt market would all but disappear without it.

“We're still not anywhere near the day where we've crossed those ideological boundaries,” says Shekar Narasimhan, managing partner at Beekman Advisors and a veteran affordable housing luminary. “The absence of a consensus around an outcome, or what would even be a good transition path to that outcome, means that we're flailing, that we don't know the answer."

Many view it as an all-or-nothing choice. On one side there's a fully private market, and on the other there's a government guarantee. But some view the Obama administration's white paper as a continuum rather than a mutually exclusive proposition.

“To me, it's a road map. You have five to seven years under Option 3, when federal credit is still extended, but under tight terms and paid for,” says Bibby. “Then you have a period where the government's only in backstop mode. And then you have a period after that where maybe the government can exit, but that may be 12 to 15 years down the road."

Prevailing silence

Beyond the bickering in Congress, the GSEs continue to serve the affordable housing industry well, offering programs like tax-exempt bond credit enhancements and 15-year permanent fixed-rate mortgages that are extremely difficult to find in the private sector.

And today's beltway inaction is a double-edged sword. For every month that passes, Fannie and Freddie increasingly lose staff to the private sector, a “brain drain” that threatens to turn them into just another inefficient, bureaucratic government agency.

“If there's no certainty as to what the future can be—and there clearly is none right now at the GSEs—then it's hard to retain those folks,” says Berman. “I'd argue that's one of the biggest risks that we face, that doing nothing will hurt the housing markets, because good people have been leaving."

But maybe all of this inaction is a blessing in disguise. Maybe the housing finance reform debate should be tabled for now, to give legislators more time to take a deep breath and less opportunity for heated knee-jerk reactions.

“I'd rather see the correct result than rush,” says Henry Cisneros, former Department of Housing and Urban Development (HUD) secretary under President Clinton and now executive chairman of real estate investment firm CityView. “The longer time passes, the more likely that Congress will fashion a response that is not in the heat of the downturn. When wiser heads prevail, and we get back to a period of cooler analysis, I don't think we'll want to throw the baby out with the bathwater."

The prevailing silence also buys the GSEs more time to start making a profit again. Should the GSEs begin to turn a profit and start paying back the government in 2013, as some predict, it could bolster the case for them to be set off on a “glide path” off of the government's dole and into a more certain future.

After drawing about $168 billion in bailout money between them, it's hard to believe that Fannie and Freddie will ever be able to pay back the U.S. taxpayer in full. But there are precedents, namely AIG and General Motors—high-profile government bailouts that are marching toward reclaiming their former status. The government could sell off the GSEs' stock, create a new regulatory framework and capitalization requirements, and spin them out.

“AIG got $180 billion, and now there's a possibility that the government can sell that off and pay most of itself back. And the government might even make a profit off of GM,” says Bibby. “The best thing Fannie and Freddie could do is return to profitability, start paying the government back, and then we'll see what happens."

Not if, but how

A lot of lofty concepts get thrown around when people talk about housing finance reform. But in practical terms, affordable housing owners and developers have just one question: What does it all mean to me?

It boils down to this: Shelter is a basic human need, so the government will always support affordable housing in some shape or form. And despite the bitter partisan divides on Capitol Hill, there are some points of consensus emerging.

Everybody agrees that private capital— not the U.S. taxpayer—must form the basis of the next generation of housing finance entities. Everyone agrees that any government guarantee must be explicit, and paid for. And there's agreement that for truly affordable housing the government must play some kind of ongoing support role.

So, the good news is, affordable housing borrowers will continue to have access to the debt they need. The cost of debt will likely rise modestly no matter which path is chosen, but it will still be available.

The bad news is, the FHA could become the only game in town.

FHA Corp.?

Even if legislators adopt a fully private model—or an emergency government guarantee in times of crisis—there would still be the FHA. And the Obama administration's white paper suggests that, in the absence of the GSEs or any future successors, the FHA should be reformed.

“One option would be ”¦ expanding FHA's capacity to support lending to the multifamily market,” the white paper reads. “We will consider a range of reforms, such as risk-sharing with private lenders ”¦ and the development of programs dedicated to hard-to-reach property segments, including the smaller properties that contain one-third of all rental apartments."

A similar but more drastic idea was floated by President Clinton in 1994, of making the FHA a government-owned corporation that could behave more like a private company. The FHA could adopt a Fannie Mae Delegated Underwriting and Servicing model, whereby private lenders share risk with the government. Under such a scenario, the FHA would remain part of HUD but have more independence— maintaining its own funds, as opposed to being subject to the appropriations process— to hire top talent and invest in technology.

Some influential voices are calling for a similar spin-off should options one or two become reality. But a reformed or reconstituted FHA is the least palatable option for affordable housing borrowers. The FHA's inefficiency needs no elucidation, and the lack of competition would mean a lack of options and innovation—the industry would be beholden to just one source.

“To me, it would be a big step backward if you pulled all government support for long-term fixed-rate apartment financing away and shoved all affordable loans into the FHA box,” says David Abromowitz, a senior fellow at the Center for American Progress (CAP) and a partner at law firm Goulston & Storrs. “The waits would become longer, and the FHA has not worked well with smaller properties, and a lot of tax credit properties are 40 or 50 units."

Scoring goals

CAP has proposed a system similar to Option 3, where chartered mortgage institutions (CMIs) would securitize loans with an explicit government guarantee. The privately capitalized entities would pay for that guarantee—a cost that would be passed on to the borrower—and a resulting FDIC-like model would protect against catastrophic losses.

In CAP's scheme, at least half of all multifamily units financed by these CMIs annually would have to be affordable to those earning less than 80 percent of area median income. The affordable housing industry, by and large, has coalesced around CAP's proposal.

“We think Option 3, with its public/ private mechanism, with a guarantee that's explicit, limited, and paid for, has really important principles,” says Terri Ludwig, president and CEO of Enterprise Community Partners, Inc. “But how can we ensure the underserved markets— low-income and rural—are served in any housing finance system? I think you need some incentives there to ensure that all segments are served."

Yet, the very idea of affordable housing goals or targets sends shivers down a lot of spines. Many conservatives believe that Fannie and Freddie exhibited in creasingly risky behavior to satisfy those goals—and that, ultimately, affordability goals were the reason for the nation's economic collapse.

“These are not goals, it's a fixed target, a condition of the license,” says Narasimhan, who's also a member of CAP's mortgage finance working group. “It forces them to not focus on the high end of the market, to let the private market do the high end, and if the FHA is doing the very low end, we want them to be a middle-market lender."

The MBA has proposed a housing finance reform scheme similar to CAP's, featuring an always-on government guarantee, mirrored in the Obama administration's Option 3. Yet, the trade group balks at the idea of an affordability mandate.

“We do think these new entities should participate in the affordable housing world, but we don't want to distort their participation by mandating goals,” says Berman. “We think that some of the affordable housing goals in the past have ended up distorting some of the behavior in the markets."

There was a time when Fannie and Freddie received credit toward those goals for buying AAA-rated commercial mortgage-backed securities (CMBS) multifamily-directed tranches. And that dynamic distorted the CMBS market by prompting conduit lenders to compete too aggressively—to compromise underwriting standards—for multifamily deals, so that Fannie and Freddie would buy the resulting securities.

Still, that's just one aspect of the collapse. Many in the affordable housing world lay the blame on a barely regulated Wall Street run amok.

“Fannie and Freddie's moderate and affordable goals were important, and I sincerely believe were not the reason for the housing meltdown,” says Cisneros. “The real source of the problem was the special investment vehicles, the collateralized debt obligations, the tranches of toxic mortgages being packaged and sold internationally with artificially inflated ratings."

Duration satiation

The bigger issue is, the debt financing needs of affordable housing owners are unique and can't really be found in the private sector. Long-term permanent debt and tax-exempt bond credit enhancements for Sec. 8 or low-income housing tax credit (LIHTC) deals aren't falling on anyone's lap. Without a government guarantee backstopping those loans, the affordable housing debt world is limited to say the least.

“What in the history of affordable housing has ever shown that the market-rate guys will buy off on that product type?” says Phil Melton, managing director of affordable housing debt at Centerline Capital Group. “It's just not a reasonable expectation."

Long-term fixed-rate debt is absolutely critical to an industry that must contain costs during a 15-year compliance period. Yet the private sector struggles to offer what Fannie Mae, Freddie Mac, and the FHA routinely process.

Most banks and other balance-sheet lenders often won't go beyond five-year loans—they have no appetite for debt of 10 years or longer. And the private securitized debt world offers little help, since most investors on the secondary market balk at buying 15-year paper.

“If you took away all government guar antees for apartment finance, you would find the debt market for tax credit deals shrinking rapidly,” says Abromowitz. “History shows that private capital will not buy 15-year or longer apartment loans in any volume. But you really wouldn't have a healthy tax credit market on the 9 percent side without long-term financing."

The market for tax credit equity, as well as construction debt, is also directly affected by the availability of low-cost permanent debt. Most banks are active LIHTC construction lenders, driven by the Community Reinvestment Act. Yet, the availability of a permanent loan takeout on the back end of a construction loan affects a project's front end financing as well.

“The question is, are you comfortable beginning your construction not knowing what your permanent debt situation is?” asks Abromowitz. “The tax credit investor can't take the risk that at miniperm maturity, there won't be a longterm takeout."

The tax-exempt bond world—the 4 percent LIHTC market—also has a gaping need for the GSEs. Both Fannie Mae and Freddie Mac have played key roles in the tax-exempt bond credit enhancement market, and continue to do so, as the New Issue Bond Program shows. That credit enhancement helps to attract bond buyers, giving a peace of mind in taking long-term risk.

Again, the key issue is duration. It's not that you can't get credit enhancements on the private market, but the credit enhancements you can get, given capital rules from a bank, are going to be five years maximum.

“You really need 10 years of stability to be able to do a tax-exempt bond and serve affordable housing needs,” says Narasimhan. “The bottom line is, that's a product that can and probably only will be provided if there is a government backstop."

From here to there

So, what can affordable housing borrowers do now to protect themselves against a worst-case scenario? Industry experts say you need to cultivate as many relationships as you can at the local level, with bankers and housing finance agencies, and in general, expand your network of capital sources.

And as the process unfolds, affordable housing owners need to stand up and be counted. Many fear the single-family industry will hijack the housing reform debate, given that it constitutes about 95 percent of the GSEs' business models.

“Affordable housing developers and stakeholders need to make sure they're finding ways to make their voices heard so we don't lose sight of multifamily housing,” says Ludwig. “There's a feeling of housing as just consumption, and I think we need to reframe that debate."

The Obama administration is working on a second white paper that would elaborate on the first, indicating in more detail what it sees as a feasible way forward. House Financial Services Committee Chair Rep. Spencer Bachus (R-Ala.) will wait on that second white paper before he introduces any kind of comprehensive reform legislation, according to Washington, D.C., insiders.

But while the future is wide open, the finish line is starting to come into focus. “I see an end result that incorporates the core of the system that exists today," says Cisneros. “We won't recognize the names Fannie Mae and Freddie Mac, or the corporate structure they have today. But I think there will be multiple entities— at least two structures to sustain competition."

The housing finance system of tomorrow will likely include a few governmentchartered entities built on the ruins of the GSEs. They'll be privately capitalized companies, with access to an explicit government guarantee for the securities they issue, much like the Ginnie Mae structure of securitizing FHA loans.

These entities will be humbled versions of the GSEs, with very limited portfolio capacity—just enough to warehouse loans pre-securitization and offer mortgages that don't have broad investor interest. As such, there may also be some level of government guarantee on the portfolio.

And they'll pay for that guarantee in the form of fees or additional basis points built into the interest rate of each loan. Those fees will be collected in a reserve to protect against losses. Taxpayers will be protected, and the affordable housing world will still have access to a vibrant debt marketplace.

“We'll get a reformed system that probably has more than two and less than five intermediaries with some level of government backstop,” says Narasimhan. “Spreads will be higher, we'll pay more for the cost of money, but it would've been worth the exercise."

That's the hope anyway, the best laid scheme. Getting from here to there—a path winding through the halls of Congress—is a different story altogether.


AS OF PRESS TIME, the House Capital Markets and Government Sponsored Enterprises Subcommittee had advanced 14 bills to rein in Fannie Mae and Freddie Mac. Other proposals are still working their way through markup in House and Senate committees and subcommittees, including the GSE Bailout Elimination and Taxpayer Protection Act (H.R. 1182/S. 693), which repeals the Affordable Housing Trust Fund and sets a deadline for GSE conservatorship to end or turn into receivership.

“We continue to advance solutions to protect taxpayers from the unlimited bailout of Fannie Mae and Freddie Mac,” said Committee on Financial Services Chairman Spencer Bachus (R-Ala.) in a statement in July. “As we continue to move immediate reforms, our ultimate goal remains: to end the bailout of Fannie, Freddie, and build a stronger housing finance system that no longer relies on government guarantees."

Here's the lowdown on the 14 bills advanced by the Capital Markets and Government Sponsored Enterprises Subcommittee. They are now pending in the House Committee on Financial Services.