In a key address on the PATH Act, House Financial Services Chair Jeb Hensarling (R-TX) explained that the Protecting American Taxpayers and Homeowners (PATH) Act principally relies upon private capital and market discipline and includes four fundamental goals essential to the development of any free market. First, the role of government is clearly defined and limited. Second, artificial barriers to private capital are removed to attract investment and encourage innovation. Third, market participants are given clear, transparent, and enforceable rules for transactions to foster competition and restore market discipline. Fourth, consumers are afforded informed choices in determining which mortgage products best suit their needs.
Chairman Hensarling said that the reform legislation introduced by Senators Mark Warner (D-VA) and Bob Corker (R-TN) is an important element in the debate. He commended Senator Corker and Senator Warner for their leadership. As someone who has worked for years on the complicated and contentious issue of housing finance reform, Chairman Hensarling salutes anyone who works hard and produces an actual plan. The Corker-Warner legislation, the Housing Finance Reform and Taxpayer Protection Act, S. 1217, would, among other things, create the Federal Mortgage Insurance Corporation (FMIC) as an independent federal agency to capitalize the housing finance system by separating credit risk from interest rate risk, and bringing in private capital to take on both.
Specifically, continued Chairman Hensarling, the PATH Act would end the costly Fannie Mae and Freddie Mac bailout; protect and restore the FHA by defining its mission; increase mortgage competition; enhance transparency and maximize consumer choice; and break down barriers for private investment capital. At the end of the day, noted the FSC Chair, the best arguments for perpetuating the GSEs are that they were standards-setters through their underwriting purchase requirements and also provided a conduit for smaller originators to access mortgage investors through the issuance of mortgage-backed securities.
According to Chairman Hensarling, these are indeed functions worth preserving in some form in a new regime. Thus, the PATH Act ushers in a new system of housing finance that separates out these functions, providing clear and transparent disclosure of mortgage data, giving certainty to contracts and their enforceability, utilizing the knowledge and networks of the Federal Home Loan Bank system, and creating an open-access utility for the issuance of mortgage-backed securities that is decoupled from the holding of long-term mortgage risks.
To ensure a smooth transition to the new system, he noted, the PATH Act implements several reforms to Fannie and Freddie in the interim. These reforms include repealing their affordable housing goals that helped precipitate the crisis; shrinking their portfolios of mortgage-backed securities and other assets; and eliminating their government-granted competitive advantages over the private sector.
Covered bond regime. The PATH Act also allows for a new-but-old method for financing mortgage lending by creating a regulatory framework for covered bonds financing. The Chair referred to a U.S. covered bond regime as ``new-but-old’’ because covered bonds have existed and been successfully used in Europe for more than 200 years, where they offer a third path to mortgage financing beyond traditional portfolio lending or securitization.
Covered bonds help to resolve some of the difficulties associated with the originate-to-distribute model of securitization. The on-balance-sheet nature of covered bonds means that issuers are exposed to the credit quality of the underlying assets, a feature that better aligns the incentives of investors and mortgage lenders than does the originate-to-distribute model of mortgage securitization. The cover pool assets are typically actively managed, thereby ensuring that high-quality assets are in the cover pool at all times and providing a mechanism for loan modifications and workouts. Also, the structure used for such bonds tends to be fairly simple and transparent.
Covered bonds have been used in Europe to help provide additional funding options for the issuing institutions and are a major source of liquidity for many European nations’ mortgage markets. The House legislation is a thorough framework that seeks to provide the same benefits to the U.S. market According to an earlier FDIC policy statement, covered bonds originated in Europe, where they are subject to extensive regulation designed to protect the interests of covered bond investors from the risks of insolvency of the issuer. By contrast, the U.S. does not currently have the extensive statutory and regulatory regime designed to protect the interests of covered bond investors that exists in European countries.