Bright-line proposal stirs debate on GSE reform

The debate over how to reform Freddie Mac and Fannie Mae, after a string of highly publicized scandals, is focusing on a proposal to limit explicitly the mortgage giants’ business to secondary markets.

The proposal, part of a bill introduced by Sens. Chuck Hagel (R-Neb.), John Sununu (R-N.H.) and Elizabeth Dole (R-N.C.), would create a “bright line” between secondary and primary mortgage markets that government-sponsored enterprises (GSEs) would be unable to cross.

The plan has stirred much debate among financial trade groups and the GSEs.

A group of eight trade associations wrote to Senate Banking Committee Chairman Richard Shelby (R-Ala.) last month in support of clearly delineating primary and secondary markets.

“It is vital…that the GSE’s focus on the secondary market mission prescribed in their charters and that the clear distinction between primary and secondary market activities be reaffirmed by Congress and the new regulator,” the groups wrote.

America’s Community Bankers (ACB), one of the letter’s signatories, wrote a separate letter a week later reiterating support for the bright line but raising concerns that the proposal could require that Freddie and Fannie get rid of their automated underwriting systems, services upon which many banks rely.

“ACB’s members, who constitute the primary market, oppose legislative language that would force the divestiture by the GSE’s of automated underwriting systems, document and custodial functions, or other activities that primary market participants regard as essential services to them,” wrote ACB Chairman Harry P. Doherty.

In mid-March, Freddie Mac began circulating a position paper opposing the bright-line proposal.

“The Bright Line proposal turns back the clock on mortgage finance by prohibiting Freddie Mac and Fannie Mae from having any role before loans are closed and funded. The proposal would significantly increase costs for all borrowers and for all lenders — especially smaller lenders,” Freddie Mac wrote.

The paper prompted a rebuttal from the Mortgage Bankers Association (MBA) titled “Why the Bright Line Helps Mortgage Markets.”

“Having a bright line separating the primary and secondary markets would provide more than mere clarity. It would retain competition, especially in the primary-market loan-underwriting function. MBA very strongly supports competition because competition, more effectively than anything else, spurs innovation and lowers prices to consumers,” the mortgage bankers’ rebuttal said.

Most recently, six trade groups, including the National Association of Home Builders and the National Association of Realtors, wrote Senate Banking Committee leaders to caution against the bright line proposal.

“The true danger of this ‘bright line’ proposal is that its overly broad approach would instantaneously preclude many of the GSE’s existing products and activities that were designed solely to increase access to mortgage credit, lower the costs of homeownership and foster innovations in home financing. For example, the ‘bright line’ provision would undermine state-of-the-art mortgage underwriting technology that has contributed significantly to the vibrancy, competitiveness, and risk management that are vital to the contemporary house finance system and would curtail the development of market-drive mortgage products and programs that meet lender and homebuyer needs.”

Industry insiders said it was likely that the language in the bill would be modified as it moves toward a Senate markup.

Smaller mortgage lenders are “not going to have the resources to develop sophisticated automated underwriting systems themselves,” said Bob Davis, executive vice president of ACB.