US Housing Finance: Our Vision for a Privately Led System

There’s a growing consensus today that the US government’s huge footprint in the $10.5 trillion mortgage market needs to shrink, with the private sector taking the lead. But there is less agreement on how the transition to a new system should take place. Here’s our perspective as investors in the mortgage market on what is needed to get the ball rolling.

In prior blog posts, I argued that a housing market entirely without government involvement is unrealistic, because it would likely result in a significant rise in mortgage rates that would shut many potential borrowers out of the market. Nonetheless, I have also argued that private investors need to take the lead in financing the purchases of American homes.

Given the size of the US mortgage market, this change is not going to happen overnight. But there are steps to facilitate the transition that can be taken now, without new legislation. My colleagues Michael Canter and Matthew Bass outline some of these steps in their recent white paper, Increasing the Role of Private Capital in the Mortgage Market .

We see two main market-based approaches that could be successful. First, for securitizations of the highest-quality mortgage pools, government-sponsored enterprises (GSEs) such as Freddie Mac could purchase reinsurance (likely in the form of a credit-linked note) to transfer the first-loss risk (the first 10%, for example) to private investors, based on the performance of a reference pool of mortgages.

For instance, the GSE could sell securities tied to the performance of 2010 vintage 4.5% coupon, 30-year fixed-rate mortgages. The investor in the credit-linked note would receive a coupon (a reinsurance premium for taking this risk). Importantly, the price of this reinsurance would serve as a market signal for the pricing of GSE guarantee fees.

For relatively low-quality collateral, we’d suggest an alternative structure, in which the GSE would not guarantee a certain percentage of losses. For example, the GSE could issue two classes of bonds from a securitization: a nonguaranteed class that would absorb the first 10% of loan losses, and a separate fully guaranteed class that would represent the remaining 90% of the securitization. There are precedents for both of these types of transactions in recent years.

Given factors such as aging populations, underfunded retirement liabilities and a prolonged period of low interest rates, we’d expect strong demand for the income-producing first-loss mortgage securities described above. In particular, we think that this new asset class could be very attractive for longer-term investors like pension funds, sovereign-wealth funds and insurers with longer-dated liabilities.

How big could this market grow? We wouldn’t be surprised to see it reach more than $250 billion in size. As a guide to the market’s potential, it’s instructive to take a look at the evolution of the high-yield corporate bond market. Initially, investors in this market were largely opportunistic, but over time the investor base broadened as investment guidelines were adjusted to accommodate the new asset class. As new investors have entered the market, the outstanding issuance of US high-yield debt has grown to $1.2 trillion. We think that a first-loss mortgage market could potentially evolve in a similar fashion.

The arrival of this new asset class would not only be good news for investors, but would contribute to a more stable housing market, and that should be a relief to all homeowners and American taxpayers.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams

Douglas J. Peebles

Chief Investment Officer—AB Fixed Income
Douglas J. Peebles is the Chief Investment Officer of AB Fixed Income and a Partner of the firm, focusing on fixed-income investment processes, strategy and performance across portfolios globally. As CIO, he is also Co-Chairman of the Interest Rates and Currencies Research Review team, which is responsible for setting interest-rate and currency policy for all fixed-income portfolios. In addition, Peebles serves as Lead Portfolio Manager for AB’s Unconstrained Bond Strategy, and focuses on managing the firm’s strategic client relationships. In 1997, he pioneered AB’s highly successful and innovative approach to global multi-sector high-income investing, which is now being adopted by other firms. Since joining AB in 1987, Peebles has held several leadership positions, including director of Global Fixed Income (1997–2004), co-head of AB Fixed Income (2004–2008) and Head of Fixed Income (2008–2016). He holds a BA from Muhlenberg College and an MBA from Rutgers University. Location: New York

Michael S. Canter

Director—US Multi-Sector and Securitized Assets
Michael S. Canter joined AB in 2007 as a Senior Vice President and is currently Director of US Multi-Sector and Securitized Assets. He is also the Chief Investment Officer of AB’s Securitized Assets Fund and Recovery Asset Fund (ABRA-S), and the former CIO of the Legacy Securities (PPIP) fund. In addition, Canter is Head of the Securitized Assets Research Group, which is responsible for AB’s investments in agency mortgage-backed securities, non-agency residential mortgage-backed securities (RMBS), commercial mortgage-backed securities and other asset-backed securities. He has particularly extensive expertise in RMBS, and in 2013 was called upon to give expert testimony to the US Senate Committee on Banking, Housing, and Urban Affairs on how US housing policy should be structured going forward. In 2015, the US Department of the Treasury asked Canter to join a working group of industry leaders focused on structural changes to non-agency RMBS that could restart that market. Prior to joining AB, he was the president of ACE Principal Finance, a division of ACE Limited, from 2000 to 2006. There, he managed portfolios of credit default swaps, asset-backed securities, mortgage-backed securities and collateralized debt obligations. Canter holds a BA in math and economics from Northwestern University and a PhD in finance from the Columbia University Graduate School of Business. Location: New York

Matthew D. Bass

Chief Operating Officer—Alternatives
Matthew D. Bass is a Senior Vice President and Chief Operating Officer of AB’s Alternatives business, responsible for strategy, acquisitions, new product development and fundraising initiatives. Prior to joining AB in 2010, he was a program director at the US Department of the Treasury, where he was responsible for the design and implementation of various real estate and real estate capital-markets programs pursuant to the Troubled Asset Relief Program. Prior to joining the Treasury in 2009, Bass was a vice president at The Blackstone Group’s GSO Capital Partners unit, where he was involved in analyzing, evaluating and executing private debt and equity investments. He began his career in the Financial Institutions Investment Banking Group at UBS, where he was responsible for executing merger and acquisition advisory and capital-raising transactions for banks, asset managers and specialty finance companies. Bass holds a BS in finance from Lehigh University. Location: New York City

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