CBO Gives Thumbs Up to CRT Markets

The Congressional Budget Office (CBO) gave a thumbs up to the mortgage Credit Risk Transfer market.

The primary function of the CBO is to “score bills”, a process by which the office predicts the effect on budget and spending of a bill over the next ten years.

In this case, the CBO produced a white paper analyzing the Credit Risk Transfer process implemented by the two GSEs, Fannie Mae and Freddie Mac.

The analysis is timely as at a December 6 hearing on housing finance reform, Michael Canter, the Senior Vice President, and Head of Securitized Assets at Alliance Bernstein, touted CRT as critical to the future of house financing reform.

What is CRT?

CRT is a program that Fannie and Freddie started in 2013 to effectively hedge default risk by spreading it around among investors.

Here’s how the CBO explained it: “At the direction of FHFA, the GSEs began undertaking transactions in 2013 to transfer some of the credit risk of their guarantees to private investors.” The CBO stated. “In most of those transactions, the GSEs issue bonds, called credit-risk notes, that pay principal and interest to investors based on the performance of an underlying pool of mortgages guaranteed as part of traditional MBSs. Credit-risk notes insulate Fannie Mae and Freddie Mac from a specified amount of mortgage losses by having those losses reduce the amount of principal repaid to holders of the notes.

“The GSEs have also experimented with reducing their exposure to credit risk by issuing subordinate MBSs that they do not guarantee, by having mortgage originators retain some of the risk on the loans sold to the GSEs, and by purchasing reinsurance on pools of mortgages.”

What did CBO Find?

The watchdog effectively gave the program a clean bill of health.

“Current CRT transactions are being executed in a fully functioning liquid market, and the GSEs use a competitive process to determine the price they will pay private investors to accept the risk being transferred. Although those transactions generate administrative expenses for the GSEs, they do not change the GSEs’ fair-value subsidy cost.5 (Fair value is a market-based measure of the federal government’s obligations and is the measure that CBO uses to estimate the subsidy cost of Fannie Mae and Freddie Mac in the federal budget.)”

The CBO further noted, “Currently planned CRT transactions are projected to reduce the GSEs’ exposure to risk by $2.8 billion in 2018….”If the economy performs as CBO projects in its January 2017 baseline macroeconomic forecast, the currently planned CRT transactions will reduce the GSEs’ total net premium income on their 2018 guarantees….”GSEs’ net premium income may be higher with CRT transactions than it would be otherwise, meaning that the GSEs will receive more in protection than they will pay in interest.”

The Rationale for CRTs

As previously noted, the CBO is not the only entity with high praise for the program, Canter noted in the previous hearing: “I view the process of Housing Finance reform as a continuum, noting that the Government Sponsored Enterprises that are at the center of the housing finance system and their regulator the Federal Housing Finance Agency [FHFA] have already made some progress in reforms post-crisis most notably through the introduction of the Credit Risk Transfer market. CRTs are debt issuances with payments linked to the credit performance of an underlying pool of loans, and they provide a layer of private capital as well as a source of market pricing of risk that the GSEs had lacked pre-crisis.”

CBO explained the rationale: “Those credit risk-transfer transactions are designed to accomplish a number of goals set out by the GSEs’ conservator and regulator, the Federal Housing Finance Agency.

“First, CRTs are designed to reduce the cost to taxpayers from the risk of future losses associated with the GSEs’ credit guarantees. Under a traditional guarantee, if a borrower defaults on a mortgage backed by the GSEs, they assume the costs of default that are not borne by the borrower or a private mortgage insurer. CRT transactions shift some of those costs from the GSEs to other private parties, such as investors, mortgage insurers, or private reinsurance firms.”

The Counter Argument

The argument against CRTs is that it is based on a faulty premise, Cantor noted, “I view the process of Housing Finance reform as a continuum, noting that the Government Sponsored Enterprises that are at the center of the housing finance system.”

Jeb Hensarling, Chairman of the House Financial Services Committee

Opponents of CRT are opponents of the system itself. The problem is the GSE structure. This is what Republican from Texas Jeb Hensarling, the Chairman of the House Financial Services Committee, has argued; and it’s frankly, what most Republicans who mention the issue will say.

The GSEs were first formed in the 1930s by an act of Congress and they are as CBO noted, “They were originally established by the federal government as private corporations with a public mission.”

They are publicly traded companies with a government mandate.

The two mortgage giants figure out underwriting standards for large baskets of loans and then securitize them.

“Fannie Mae and Freddie Mac operate mainly in the secondary (or resale) market for single-family mortgages. They buy mortgages that meet certain standards from banks and other mortgage originators; pool those loans into mortgage-backed securities, which they guarantee against most of the losses from defaults on the underlying mortgages; and sell the MBSs to investors—a process known as securitization.” CBO noted.

But both have been involved in a sea of corruption, including a 2016 expose by The Industry Spread of more accounting fraud: fraud which occurred while receiving government funds.

Indeed, a close look at both companies indicates that there is systemic corruption with accounting fraud, cronyism, recklessness, favoritism, and sweetheart loans, being only a few of the scandals by both- scandals which track back decades.

To those like Hensarling, it is their structure which is the source of the corruption. Being so close to the government only breeds this sort of shenanigans.

So, throwing out the model itself- eliminating Fannie and Freddie- is the proper course of action.

The government should get out of the mortgage securitization business entirely, Hensarling would argue.