This story appeared in Jim Hamilton's World of Securities Regulation.
With a Republican House in the 112th Congress, the legislative agenda for financial regulation will shift somewhat but there is still an opportunity for reform legislation next year. For example, there is a growing bi-partisan consensus for the reform of government sponsored enterprises such as Fannie Mae and Freddie Mac, as part of the overall reform of the securitized secondary mortgage market. Reform of the GSE’s has been a special concern of Rep. Spencer Bachus (R-AL), who is slated to become the Chair of the House Financial Services Committee. As part of GSE reform, and as a replacement for the mortgage securitization function that GSEs currently perform, there is growing bi-partisan effort to pass legislation creating a US covered bond market under SEC supervision. In late July, the House Financial Services Committee reported out by voice vote the US Covered Bond Act, HR 5823. It has bi-partisan support, having been co-sponsored by Rep. Bachus and Rep. Paul Kanjorski.
Recently, Rep. Bachus outlined the principles for draft legislation to reform the secondary mortgage market, with a covered bond market as an integral part of the effort. The legislation would sun-set over a four-year period the current GSE conservatorship and wind down the federal subsidies granted through their charters. The legislation would also introduce full transparency and accountability to the secondary market. The draft would reduce leverage by phasing in, over four years, capital requirements that are consistent with global standards for large, complex financial institutions.
The legislation would create a regulatory safe-harbor for mortgages that meet underwriting standards that are consistent with the Federal Reserve Board's final HOEPA rule. This provision is designed to encourage the return of private capital to the mortgage finance market by giving investors transparency and confidence that the loans they purchase meet appropriate underwriting standards, including the ability to repay and the integrity of the documentation. This provision may involve amendments to the Dodd-Frank Wall Street Reform and Consumer Protection Act, which establishes only a limited safe harbor from legal liability and provides for expanded assignee liability for mortgages that meet stringent underwriting standards, thereby making it difficult to assess the legal risk of investment in mortgages.
A centerpiece of the Bachus reform legislation is the establishment of a regulatory framework for a U.S. covered bond market. Covered bonds are an innovative source of private mortgage market financing which have worked well in many European countries. They are also a private market solution to the need for market participants to have "skin in the game." A covered bond is a form of debt issued by a financial institution where a specific set of high quality assets, typically loans, are set aside into a pool for the benefit of the bondholders. The issuers of covered bonds are responsible to their bond holders for the risk posed by the underlying loan pool. For example, if the underlying loans default, bond holders can make claims against the issuer. And if the issuer becomes insolvent, bondholders retain full claim on the loan pool. Additionally, issuers of covered bonds are required to account for the risk posed by their bonds on their balance sheets.
Rep. Spencer Bachus has historically supported this type of legislation. In a letter to Senate Banking Committee Chair Chris Dodd, that he co-signed with Rep. Scott Garrett, principal author of the covered bond legislation, Rep. Bachus said that Congress must consider creative means to enable the private sector to provide funding for additional consumer credit and alternative options for financial institutions to finance their operations. Establishing a U.S. covered bond market would further each of these shared policy goals. The letter also noted that a robust U.S. covered bond market would provide a significant source of much-needed liquidity for home mortgages, commercial real estate (including multi-family), student loans, and public sector financing.
An effort to include GSE reform in the Dodd-Frank Act failed as House and Senate managers of Dodd-Frank decided to do GSE reform in separate legislation. The McCain-Shelby-Gregg GSE amendment, which was not adopted, would have provided transparency to the conservatorships of the GSEs by establishing much needed investigative oversight. It would also have required Fannie Mae and Freddie Mac to be included in the Federal budget as long as they are in conservatorship or receivership status.
Another piece of legislation that appears to be bi-partisan involves the reform of PCAOB procedures. In a letter to House Financial Services Committee Chair Barney Frank and Ranking Member Spencer Bachus, PCAOB Acting Chair Dan Goelzer asked for legislation amending Sarbanes-Oxley so that Board disciplinary hearing against individual auditors and accounting firms will be public. From the initiation of the PCAOB disciplinary proceeding through the SEC decision to let the sanctions commence, the entire proceeding takes place behind closed doors. The closed nature of Board disciplinary proceedings is in sharp contrast to similar SEC proceedings against auditors. The draft legislation would make PCAOB disciplinary proceedings public when the Board decides that the evidence gathered in an investigation warrants charging a firm or individual with a violation, while at the same time maintaining existing confidentiality of Board inspections. The draft would also retain the Board’s flexibility to order non-public proceedings in appropriate cases.