Housing finance reform, the great unfinished business of the financial crisis, got a push forward Tuesday from the top Democrat and top Republican on the Senate banking committee. Chairman Tim Johnson, D-S.D., and ranking member Mike Crapo, R-Idaho, put forward
Housing finance reform, the great unfinished business of the financial crisis, got a push forward Tuesday from the top Democrat and top Republican on the Senate banking committee. Chairman Tim Johnson, D-S.D., and ranking member Mike Crapo, R-Idaho, put forward a proposal to replace Fannie Mae and Freddie Mac, which currently back three-fifths of all new home loans.
Instead of those two government-sponsored mortgage guarantors, which have been under direct federal control since their collapse in 2008, a new federal entity would, in return for a fee, insure private-sector mortgage securitizers against catastrophic losses. The private companies would put up 10 cents of their own money for every dollar of risk, and the federal insurance would cover losses above that stake, using accumulated insurance fees. This is roughly the approach outlined last year by banking committee members Mark Warner, D-Va., and Bob Corker, R-Tenn.; the Obama administration has signaled its support.
Ideally government would get out of the mortgage securitization business, limiting its intervention to a program targeted transparently at low-income, first-time home buyers. Political realities being what they are — chiefly, the housing sector’s dependence on the 30-year, fixed-rate mortgage — such an approach is not in the cards, at least for now. The Johnson-Crapo approach, modeled on Corker-Warner, aims to create a second-best solution. In contrast with the Fannie-Freddie model, in which government implicitly guaranteed the liabilities of two nontransparent, highly politicized entities, the proposed alternative would expressly guarantee not firms but assets — mortgages — whose risks can be more readily analyzed.
As with all federal insurance programs, a major concern about the proposed entity is that interest-group lobbyists would pressure it to charge too little for the federal guarantee, thus replicating Fannie and Freddie’s distorting effect on capital allocation. Rep. John Delaney, D-Md., a former financier, has suggested a solution: Private-sector entities should be allowed to bid on the security-guarantee business as well, assuming a share of the government’s risk in return for a share of the profits. Under Delaney’s proposal, the private-sector bids would set the price of the federal guarantee, thus ensuring that it reflects market considerations over political ones.
Ultimately, the quality of the underlying mortgages will determine how much exposure the government — and, by extension, the taxpayer — takes on. Poorly underwritten loans brought down both the “private-label” mortgage securities industry and the Fannie-Freddie duopoly. Yet a wide array of interest groups, from the housing lobby to low-income advocates, can be counted on to insist that standards be relaxed, bit by bit, in the name of homeownership.
The Johnson-Crapo proposal adopts federal “qualified mortgage” standards that basically rule out “no-doc” loans and the like — but it would also make mortgages with down payments as low as 3.5 percent eligible for government-backed securitization. Congress must resist any temptation to debase credit standards. If recent history teaches anything, it’s this: A mortgage securitization system is only as strong as its weakest borrower.
