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An overriding concern.

An Overriding Concern

Critical legislation to foster the growth of the secondary market now rests in the hands of the states. Federal law gave the states until October 3 to undo the foundation laid in 1984 to help the private-label MBS market grow, and some states are opting to turn back the clock.

Looking back, the year 1984 was a watershed year for the mortgage-backed securities market. It was the year Congress passed and the president signed into law the Secondary Mortgage Market Enhancement Act (SMMEA).

The new act overrode state legal investment laws and blue-sky laws for private-label mortgage securities. These are securities backed by mortgage loans that do not conform to secondary market agency specifications. Such mortgages would include jumbo loans that exceed the agency's purchase limits, loans with nonstandard terms or underwriting and some loans not even heard of in 1984--for example, loans in the process of disposition by the Resolution Trust Corporation (RTC).

The legislative history notes that the state override provision was necessary because many state laws establishing legal investment criteria were written when MBSs were generally unknown. Thus, these securities were adversely affected by constraints that artificially limit demand without regard to the soundness of the particular investment. The statute's pre-emption of the state blue-sky laws was included based on the rationale that such registration requirements duplicated the requirements of the federal securities law. Furthermore, state blue-sky law compliance imposed additional fees on the total cost of marketing these securities.

However, the act did not override state laws without placing stringent guidelines on the quality of mortgage securities that would qualify for SMMEA eligibility. Eligible MBS must be rated in one of the two highest rating categories by at least one nationally recognized statistical rating organization, as well as meet a strict definition of "mortgage-related security" as defined in the law. The law also permitted states to reimpose their own investment limits or registration requirements or both, seven years from the date of enactment, which was October 3, 1984. The seven years are up in October and a number of states have begun to override either or both of these provisions.


SMMEA legislation originated in the U.S. Senate in August 1983. The late Senator John Tower (R-TX), who was at that time chairman of the Housing Subcommittee of the Banking, Housing and Urban Affairs Committee, was the leading advocate for this legislation. The Republicans were the majority party in the Senate at that time. On August 4, 1983, Senator Tower introduced S. 1821, and in a letter to the chairman of the House Banking Committee, Fernand St Germain (D-RI), Tower stated that this legislation was essential to the development of the private sector in the secondary market.

The SMMEA legislation in the U.S. House of Representatives was referred to two committees: the Banking, Finance and Urban Affairs Committee and the Energy and Commerce Committee. The House Banking Committee's Housing Subcommittee, chaired by Congressman Henry Gonzalez (D-TX), was directly involved in SMMEA, because Title II of the bill amended provisions of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) Charter Acts, which were in the housing subcommittee's jurisdiction. The Energy and Commerce Committee had jurisdiction over the amendments to the securities laws. The staffs, however, worked together in developing the legislation, because the changes being made under SMMEA were being done to facilitate national housing policy. The U.S. Senate, on the other hand, does not have this jurisdictional split between housing and securities laws, thus the Senate Banking Committee had sole jurisdiction over this legislation.

The impetus for the SMMEA legislation, S. 1821, was a growing understanding that new sources for mortgage money needed to be found as more and more demands were placed on the credit markets. Housing market observers realized that the magnitude of demand for mortgage credit could not be met altogether by the existing federal agencies.

The mood in both the House and Senate in the early 1980s was very different than it is today. The aftermath of the Financial Institutions Reform, Recovery and Enhancement Act (FIRREA) has produced a shift toward retrenchment and limitation, while in the mid-1980s, especially in regard to the housing markets, the prevailing sense was a need for expansion. The mortgage securities markets at that time were narrow, limited primarily to GNMA, Fannie Mae and Freddie Mac. Private-issue mortgage securities really had not been able to tap into the capital markets in any significant way. Also, the interest-rate environment during this time was not very attractive to homebuyers and, as a result, many families had been locked out of the housing market. Thus, Congress was looking for a mechanism to expand the capital available for housing, as well as lower the interest rate for home mortgages. They were looking at a new frontier for housing finance.

Conditions were ripe

All three, full committees held thorough hearings on the issues that ultimately became part of SMMEA. In the House, hearings were held on H.R. 4557 and in the Senate, hearings were held on S. 1821. The witness list for the hearings included many of the trade associations representing the housing industry such as the Mortgage Bankers Association of America (MBA) and the National Association of Realtors (NAR), and representatives of the finance industry such as the Dealer Bank Association, the National Council of Savings Institutions and the U.S. League of Savings Institutions. The capital markets were represented at the hearings by Lewis Ranieri, who was managing director of Salomon Brothers and a well-known innovator in the MBS area, and Richard Pratt, who was president of Merrill Lynch Mortgage Capital and former head of the Federal Home Loan Bank Board.

The majority of the testimony called for passage of the legislation on the grounds that the removal of statutory and regulatory impediments would enable privately issued mortgage securities to become a more efficient means of financing housing. With a prediction that by the end of the decade, more than 80 percent of all mortgages would be financed through the secondary market, it was argued that this legislation would provide the foundation for investor acceptance of mortgages as a competitive investment.

Another condition that prompted Congress to consider legislation to encourage the development of the private-label market was the uncertainty that prevailed in the interest rate environment. By early 1984, the 30-year, fixed-rate mortgage was around 12 percent, down from a high of 15 to 16 percent a few years earlier. However, traditional lenders, such as thrifts and banks, were less willing or able to hold long-term, fixed-rate mortgages in portfolio.

The anticipated scope of the housing finance market over the next decade also lent support to the legislation. Former Congressman Steve Bartlett (R-TX), a leading advocate for this legislation in the House Banking Committee, quoted research during the hearings that predicted that $1.6 trillion in mortgage credit would be needed by 1994; to provide for this need, it would take all of the available players operating at full capacity.

Senator Donald Riegle (D-MI), an advocate for the legislation in the Senate, encouraged the changes in the law in order to ensure that housing finance would be available at reasonable rates for moderately price homes in all parts of the country throughout the business cycle.

A very compelling argument made by the private sector during the hearing process was the impact SMMEA legislation would have on home mortgage interest rates. Lew Ranieri predicted that the mortgage rate could be lowered by 50 basis points. Dick Pratt pointed out that even if it were only 12 or 13 basis points, that would almost be the same as writing a check back to the homebuyer for 1 percent of the amount of the mortgage.

All of these positive arguments for increasing homeownership persuaded Congress that the legislation was needed. The message was that private-label participation in the housing finance markets was necessary to keep the citizens of the United States the best housed in the world.

The Reagan administration, however, was not as anxious to jump on the bandwagon. While it believed strongly in expanding the private-label MBS market, it did not look kindly on the expansion of powers for Fannie Mae and Freddie Mac, which were included in Title II of both the House and Senate bills. The administration had long been committed to the privatization of these two entities and it believed the changes proposed in the bill were moves in the wrong direction. Administration officials stated their opposition in a letter from the Treasury Secretary to the Senate Banking Committee Chairman Jake Garn (R-UT) in October 1983.

However, the changes proposed to the Fannie Mae and Freddie Mac Charter Acts were an important element in getting SMMEA passed. When the House passed its 1983 housing bill, H.R. 1, the changes to the charter acts were included. However, they ran into trouble in the House/Senate Conference because the Senate wanted to include the securities law change from the Tower bill in the housing legislation. Because of the jurisdictional differences in the House and Senate, the securities issues could not be included in a bill solely under the jurisdiction of the House Banking Committee and thus the Fannie Mae and Freddie Mac provisions were dropped from H.R. 1.

Chairman Gonzalez was committed to changes to the charter acts and thus advised the administration that in order to gain support for expanding the private-label market these changes would have to be included. Thus, when the House passed H.R. 4557, under a non-controversial procedure known as "suspension of the rules," on September 11, 1984, both Title I dealing with the expansion of the private-label market, as well as Title II, which gave Fannie Mae and Freddie Mac expanded authority were included. President Reagan signed the bill into law on October 3, 1984.

Today's housing finance market strongly reflects the positive effects of SMMEA. In the six-and-a-half years since its passage, the mortgage securities market had grown to a healthy $1 trillion in 1991, heading toward the $1.6 trillion predicted during the legislative hearings in 1984.

Senator Riegle had urged the passage of this legislation on the grounds that mortgage credit needed to be available throughout the business cycle, and this is evident today. Although the savings and loan industry has collapsed, a credit crunch has hit the commercial banks and investors are boycotting real estate investments, homebuyers continue to be able to get financing for single-family mortgages at comparatively low interest rates.

Fences and walls

Unfortunately, these positive effects may be diminished by actions being taken recently in many states to override provisions of the SMMEA statute. The federal statute that led to public issuances in 1990 of more than $22 billion of private-label mortgage securities, and helped the market this year start off at a $31 billion annualized pace of issuance (see Chart 1), is being altered. The uniformity produced by SMMEA, where all 50 states could be counted on to have the same investment guidelines for mortgage-related securities, is now disintegrating into a patchwork quilt.

Modifications to SMMEA are not being proposed and voted on because of any problems with these securities. In fact, there have been no investor losses with publicly issued agency or private-label securities, and the 1984 legislation left state antifraud statutes and other stringent requirements on dealers and underwriters intact. Yet, it seems that the seven-year override expiration date appears to be occurring at the wrong time. Very little override action was taken prior to 1991, although four states took action to override the blue-sky law exemption in 1985 and 1986 (see Table 1). All of the states that have taken action to override Section 106 of SMMEA this year have done so through their insurance investment statutes.

The impetus for these changes really began in January of this year when the National Association of Insurance Commissioners sent out a notice to all 50 state commissioners reminding them that they only had until October 3 of this year to override the legal investment and blue-sky pre-emption of SMMEA. It appears that the state override legislation is being proposed because of the difficulties being experienced by the insurance industry. The state insurance regulators, in their efforts to deal with the solvency issue as it relates to the insurance industry, have opted to pre-empt the federal legislation.

There is a great deal of concern in the marketplace that the overriding of SMMEA could unravel the progress that has been made during the last six-and-a-half years to develop a national market for private-label securities with maximum liquidity. The Public Securities Association (PSA) along with Freddie Mac, MBA, the NAR and other housing-and finance-related trade groups have worked very hard in New York and California to encourage those legislatures not to override SMMEA in order to preserve the continuity and stability that has developed in the market since 1984. However, on July 3, 1991, the New York legislature passed SMMEA-override legislation as it applies to legal investment laws for insurance companies. At the time this article went to print, New York's legislation was awaiting the governor's signature. California has not yet taken any final action on override legislation.

There is no doubt that Congress gave the states the opportunity to override the pre-emptions. However, this federal law has worked well and has accomplished what its authors intended. No one can predict the exact consequences of these states' actions, but there is some indication from the markets that rates could rise and some homebuyers could be locked out of the housing market.

It is unfortunate that, as we get so close to the deadline, and for reasons not directly related to the issue, the private-label mortgage securities market finds itself in jeopardy. But those with the most to lose from this rather arcane debate will be the American homebuyer, because overriding SMMEA has the potential to undo the significant progress that has been made in expanding the availability of mortgage finance.

Table 1 Where SMMEA Stands
Overriden No Action Pending
Alaska Arizona** Nevada California
Arkansas* Colorado New Hampshire
Floria Connecticut New Jersey
Georgia Delaware North Carolina
Illinois Hawaii North Dakota
Indiana Idaho Ohio
Kansas Iowa Oklahoma**
Louisiana* Kentucky Oregon
Minnesota* Maine Pennsylvania
New Mexico* Maryland Rhode Island
New York*** Massachusetts South Carolina
South Dakota Michigan Tennessee
Utah Mississippi Texas
Virginia Missouri Vermont
West Virginia Montana Washington
 Nebraska Wyoming

* passed override legislation in 1985 or 1986 ** override legislation introduced but did not pass *** passed and is awaiting the governor's signature as of

7/10/91 [Chart 1 Omitted]

Bonnie C. Caldwell is vice president for government relations at the Washington, D.C. office of the Public Securities Association. Previously she was a professional staff member of the U.S. House of Representatives Subcommittee on Housing and Community Development.
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No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1991 Gale, Cengage Learning. All rights reserved.

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Title Annotation:effect of the Secondary Mortgage Market Enhancement Act
Author:Caldwell, Bonnie C.
Publication:Mortgage Banking
Article Type:Cover Story
Date:Aug 1, 1991
Previous Article:Economic trends.
Next Article:A new congressional order.

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