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After 15 months of unprecedented intervention in the secondary mortgage market, the Federal Reserve—currently the proud owner of nearly 25 percent of mortgage debts—is calling it quits. The Fed's $1.25 trillion emergency program to stabilize the U.S. housing market through the purchase of mortgage-backed securities (MBS) officially expires today.

First announced in November 2008, the Fed initiative to purchase MBS issued by government sponsored enterprises (GSEs )—including Fannie Mae, Freddie Mac, and Ginnie Mae—has largely been viewed as a catalyst in spurring the nascent recoveries in both the housing and stock markets, helping to lower home mortgage rates and free up capital for private investors. In particular, market analysts credit the Fed purchasing program with paving the way for a record $375.4 billion of investments into bond mutual funds in 2009, as lower returns on mortgage securities led investors to corporate bonds, equities, and other riskier assets.

At a time when the U.S. economy remains fragile, the Fed’s departure from the housing sector may help determine just how fragile economic conditions really are. For months, market observers have raised concerns that a Fed exit could cause significant spikes in mortgage rates, leading to higher foreclosures and a slump in investor confidence. In fact, Fannie Mae's and Freddie Mac’s February announcement that they will repurchase $200 billion in delinquent mortgage loans, was a tacit acknowledgement that government backstops cannot be removed swiftly.

However, a number of analysts are also predicting that the effects of the Fed pullout will be rather minimal, as the current shortage of AAA-rated debt has made private fund managers increasingly eager to begin reinvesting in MBS, especially when such securities are backed by propped-up GSEs like Fannie Mae and Freddie Mac. In addition, these analysts also project that U.S. banks—which have steadily increased capital levels and are now flush with extra cash—will step up to fill the void left by the Fed.

The role of both Fannie and Freddie in ensuring a smooth transition for the housing finance system will be something to watch closely over the next few months. The GSEs are under intensified scrutiny on Capitol Hill, as the Obama administration prepares a sweeping proposal for a GSE overhaul. Treasury Secretary Tim Geithner told Congress last week that the administration will initiate a public comment period on April 15 in order to solicit ideas for Fannie and Freddie’s restructuring.
 

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…But first, the House Rules Committee will meet this afternoon and Wednesday to consider nearly 250 amendments that have been filed to the Wall Street Reform and Consumer Protection Act of 2009 (H.R. 4173), initiating a process that will set the parameters for a series of votes to occur during three days of floor consideration that could begin later this week.

Reflecting increasing pressure from Capitol Hill for the Obama administration to ramp up existing mortgage foreclosure prevention efforts, Rep. John Conyers (D-MI) and Zoe Lofgren (D-CA) have offered an amendment to H.R. 4173 that reincarnates a highly controversial provision—known as “cramdown”—which would allow bankruptcy judges to modify the terms of troubled mortgages.

Identical to the language passed by the House in March under the Helping Families Save Their Homes Act of 2009 (H.R. 1106), the Conyers-Lofgren amendment would authorize bankruptcy courts to modify mortgage repayment periods, interest rates and fees, and even the principal balance if a borrower provides evidence that efforts to complete a loan modification through the Obama administration’s “Making Homes Affordable” program have failed. Despite passage in the House, the cramdown legislation has twice been voted down in the Senate during separate votes in 2008 and 2009.

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The Treasury Department yesterday released its new improved “Making Home Affordable” (MHA) program that will now offer assistance for second mortgages, such as home equity loans, in addition to assistance with first mortgages. The administration announced the MHA in February and released the details in early March. Tuesday’s announcement addressed the expansion of MHA as well as more support for the Hope for Homeowners program. Treasury estimates that 50 percent of “at risk” mortgages also have second liens. Under the new program, both first and second mortgages would be modified “in tandem.” Interest rates on second loans would be reduced to one percent, unless they are interest-only loans, in which cases the rate would be two percent. The term of the modified second loan would be extended to match the term of the modified first mortgage. After five years, the interest rate on the second would be adjusted to the same rate as the modified first mortgage, and the second mortgage would be re-amortized over the remaining term at the higher rate. The MHA also includes “pay for success” incentives for servicers and borrowers similar to those announced for first mortgage relief.

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There was plenty of activity in Washington this week but none of it enough to settle the roiling stock market, which keeps sinking like a rock. Is there too much activity or not enough of the right kind of activity?

From the White House and the Treasury—The Obama Administration released the details of its “Making Home Affordable” program, which was introduced in February. With incentives for mortgage holders and servicers, audit and documentation requirements, and qualification limits, major industry players such as the Mortgage Bankers Association and the American Bankers Association reacted positively to the new details.

From the Treasury—Secretary Tim Geithner was on Capitol Hill most of the week defending and explaining the president’s budget proposal, especially the $250 billion “contingent reserve” amount in the Treasury budget to support up to $750 billion worth of asset purchases. Geithner assured the Senate Finance Committee that the $750 billion is not an estimate of future rescue efforts, but rather “just a recognition of reality that it’s possible we’re going to need to do this with more resources.” The Secretary promised to provide more details in the coming weeks on future bailout efforts, including plans for the remaining $300 billion of TARP funds, and the eagerly anticipated public private partnership to take on troubled assets.

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Congress was out of town when President Obama unveiled his “Homeowner Affordability and Stability Plan” this week, but that has not stopped key Members of Congress from weighing in on the plan and handicappers from starting to take odds on how reaction to the plan will affect other issues at play in the Capital.

Unsurprisingly, Speaker of the House Nancy Pelosi (D-CA) applauded the Obama plan and promised more relief, saying,

“Congress stands ready to complement the Administration’s efforts by acting on Judiciary Committee Chairman John Conyers’ legislation to reform our bankruptcy laws, so that judges can modify mortgages and responsible homeowners can stay in their homes.”

The Conyers’ legislation would alter bankruptcy laws so that judges could reduce or “cram-down” the mortgage principal and/or payments on a borrower’s primary residence.

Just as unsurprising was the reaction of Pelosi’s counterpart, House Minority Leader John Boehner (R-OH) who, along with House Minority Whip Eric Cantor (R-VA), sent a letter to the president with a list of  “key questions” about the plan. Their questions are compelling regardless of where people stand on the plan.

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Who appointed the G7 (+1) to its perch? The finance ministers for the main protagonists in World War II (1939-1945) met in Rome over the weekend to discuss the world economic crisis. Does a meeting of this nature that excludes India and China truly have a hope of wrapping its collective mind around the problems and their possible solutions?

Is ideology standing in the way of the most elegant solution to the U.S. banking crisis? Give former President George W. Bush his due: when the dimensions of the banking crisis became apparent to him, he scrapped a "market guy" ideology and poured taxpayer money into the banks. Is the Obama Administration willing to take what for them would be a similar ideological leap? Is their unwillingness to do so behind the complex public-private partnership at the center of the Geithner proposal to deal with troubled assets? Is there a similar reason behind the relatively light-handed approach Geithner would take to pushing the banks to resume lending?

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With each passing day it becomes more apparent that neither the Congress nor the Bush Administration has an appetite for significant new actions to aid the financial system or the economy at large before the end of the year. Congressional leaders on Thursday made it clear that passage of an economic stimulus package or a package to aid the auto industry were looking increasingly difficult. At the Treasury Department, consideration is being given to making Capital Purchase Program assistance available to non-bank financial institutions, but no guidelines for how that might happen or what form the assistance may take have emerged. Meanwhile, congressional Republicans have begun clamoring for more information on the actions Treasury and the Federal Reserve have already taken to assist ailing financial institutions and other companies.

Sen. Chuck Grassley (R-IA), Ranking Member of the Senate Finance Committee, sent a harshly worded letter to the Treasury Secretary and Federal Reserve Chairman "to express concerns and receive answers to questions" he has regarding implementation of the Emergency Economic Stabilization Act of 2008 (EESA). In a statement released along with his letter, Grassley said of the implementation thus far, "When you see so many changes, you wonder if they really know what they’re doing."

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Treasury Secretary Hank Paulson today announced the Treasury Department will assist nonbank financial institutions with Troubled Asset Relief Program (TARP) funds and that the department will not use any funds for the original stated purpose of the program—the purchase of troubled assets from banks. The announcement of his intention to provide assistance to nonbank institutions represents a new step for Paulson. In making the announcement, the Secretary acknowledged that Treasury has not worked through the issue of funding organizations that are not federally regulated, however they are “designing further strategies for building capital in financial institutions,” and he said, “We will also consider capital needs of non-bank financial institutions not eligible for the current Capital Purchase Program.” He focused his remarks on the importance of shoring up the asset-backed securitization market by working with the Federal Reserve to develop a liquidity facility for AAA securities. Paulson acknowledged the need to “get lending going again,” and said, “While this securitization effort is targeted at consumer financing, the program we are evaluating may also be used to support new commercial and residential mortgage-backed securities lending.”

The accompanying announcement that Treasury does not intend to use TARP funds to purchase troubled assets as originally planned was a surprise to most observers. Paulson said he would seek to address the liquidity issues in the mortgage finance market by making additional capital available to banks if those funds were matched with private capital.

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October 23 was a busy day for Federal Deposit Insurance Corporation Chairman Sheila Bair. In the morning, she testified before the Senate Banking Committee and made headlines about what the FDIC is doing to assist homeowners avoid foreclosures. In the afternoon, she presided over an FDIC Board of Directors meeting wherein the board adopted an interim rule for implementing the Temporary Liquidity Guarantee Program.

Under the Emergency Economic Stabilization Act of 2008 (EESA), the Treasury Secretary has authority to modify mortgage loans in order to prevent foreclosures. Senate Banking Committee Chairman Chris Dodd claims authorship of those provisions in the bill. However, in recent days, Congressional Democrats have complained the Bush Administration is putting too much emphasis on shoring up banks and not enough on helping homeowners directly. In fact, earlier in the week, House Financial Services Committee Chairman Barney Frank (D-MA) and Rep. Maxine Waters (D-CA) wrote a joint letter to President Bush urging him to appoint Bair “to head a government-wide effort to supervise and coordinate” a foreclosure reduction program.

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There has been a seismic shift in Congressional attitude over the past 48 hours. Skepticism over the administration’s plan has evolved into hardened resolve to achieve consensus and pass a financial relief package as soon as possible. People are still reluctant to commit to a timeframe, but the pace has quickened. Whereas two days ago, Senate staff were waiting for their House counterparts to draft a plan, reports now indicate that both sides began working together yesterday to craft a single, unified plan.

Publicly, several lawmakers, including Senate Banking Chairman Chris Dodd (D-CT) and House Financial Services Chairman Barney Frank (D-MA), have said Congress and the administration are very close to striking a deal in the next “day or so.” At 10 a.m. this morning Frank hosted Dodd as well as Sen. Bob Bennett (R-UT), a senior member of the Senate Banking Committee, and Rep. Spencer Bachus (R-AL), the ranking member of the House Financial Services Committee, to continue drafting the plan. We have reports that the drafting session will expand to include others and will continue all day. Congressional leaders are working to have a consensus plan by today’s 4 p.m. meeting at the White House with President Bush and the presidential candidates.

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The Treasury Department this past weekend submitted legislation to the Congress requesting authority to purchase troubled assets from financial institutions in order to promote market stability, and help protect American families and the US economy. This program is intended to fundamentally and comprehensively address the root cause of our financial system's stresses by removing distressed assets from the financial system.

The following description reflects Treasury's proposal as of Saturday afternoon.

Scale and Timing of Asset Purchases. Treasury will have authority to issue up to $700 billion of Treasury securities to finance the purchase of troubled assets. The purchases are intended to be residential and commercial mortgage-related assets, which may include mortgage-backed securities and whole loans. The Secretary will have the discretion, in consultation with the Chairman of the Federal Reserve, to purchase other assets, as deemed necessary to effectively stabilize financial markets. The timing and scale of any purchases will be at the discretion of Treasury and its agents, subject to this total cap. The price of assets purchases will be established through market mechanisms where possible, such as reverse auctions. The dollar cap will be measured by the purchase price of the assets. The authority to purchase expires two years from date of enactment.

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