STACR founder Don Layton talks the early and current days of the market

In the latest Freddie Mac podcast former ceo Don Layton describes the birth of the CRT market and says that following the launch of the first STACR deal in early 2013 he was instructed by the FHFA to share the secret recipe with Fannie Mae.

“Interestingly, we were then told to take our documents and give them to Fannie Mae because the FHFA did not want them to take so much time to reinvent the wheel and they could then follow with their CAS bonds,” he recalls.

He says that the first FHFA GSE scorecard in spring 2012 advocated credit risk transfer, but when he arrived as the new ceo in May 2012 he found Freddie was “going around in circles” and the senior management and the board didn’t know what to make of the concept.

“I also learned from the FHFA that Fannie Mae had no interest in it and had done virtually nothing,” he adds, in conversation with current vp of single-family credit risk transfer Mike Reynolds.

Layton, however, came from a non-GSE background. He had spent the greater part of his career at JP Morgan and then JP Morgan Chase, occupying some very senior positions, including, for example, managing global capital markets and, from 2002-2004, serving as co-ceo of the investment bank.  These experiences profoundly coloured his views on how Freddie should proceed.

“I knew the buy and hold business was not a winner for a financial intermediary like a GSE or a bank, as it means you have too much concentration of risk and requires too much capital, and is usually low return,” he says.

He had seen the development of the syndicated loan mechanism and the concept of risk-sharing at JP Morgan in the early 1990s, for example.

Layton had also been involved in the evolution of bank capital concepts from the 1970s through to Basel I and knew that as CRT was about risk reduction it was also about capital reduction.

So, he had a clear roadmap and certainty of priorities when he came through the doors on his first day at Jones Branch Drive, McLean, Virginia.

“I arrive at Freddie Mac as the new ceo on Monday and by Thursday of the same week I was doing a deep dive into CRT. I overrode all management and board ambivalence and told them this something we had to do and why,” he says.

One of the first controversial decisions was to release loan data to the market so investors could assess risk and reward of STACR deals. Layton also had to preside over the development of an in-house capital system to determine the economic viability of the mechanism.

Looking back on those early years, Layton compares it to “Present at the Creation” -the memoir by Harry Truman’s famed secretary of state Dean Acheson about momentous foreign policy decisions that shaped the post-war world.

Nine years on, the CRT mechanism has gone through ups and downs, often in rapid succession, but with safe negotiation of Covid turmoil and the advent of Sandra Thompson’s regime at the FHFA it appears to be once again in an up period. Layton is convinced that it delivers two major benefits to the GSE sector.

Firstly, it reduces systemic risk. Until it came along the GSEs were a “giant glob of trillions of dollars of single family mortgage risk… and this didn’t work very well in 2008,” he says. CRT is the only method which can diversify risk.

Secondly, it provides market discipline, and this is particularly pertinent given the periodic waves of criticism the GSEs attract from both sides of the political divide. The GSE credit box is deemed either too loose or too tight, too generous or not generous enough, but the CRT market provides irrefutable evidence of the right market price for mortgage risk.

“We now have over 100 large financial institutions and investors who are deciding what an acceptable credit is and what they’ll pay for it, putting hard cash on the line,” he says.

Opponents inside the Beltway have also sometimes claimed that the CRT market is only open when conditions are propitious and could be shut for years on end, but in fact the evidence of the last decade indicates that the sector is far more resilient than its naysayers suggest.

During the Covid crisis it suffered losses, but remained open, and by May/June 2020 signalled it was willing to on new risk.

“Since we started in 2013 up until the pandemic hit, I estimate - and I’m not exaggerating here - it was available 99% of the time. I only remember it shutting for a short period of time with the surprise vote on Brexit - which obviously has nothing to do with mortgages in the US,” he says.

Simon Boughey