Few tasks facing Congress are more necessary than housing finance reform. The Fannie Mae-Freddie Mac debacle cost taxpayers tens of billions of dollars and left the mortgage market in government-controlled limbo. Yet few tasks are more thankless: Fixing the system whereby home loans get packaged into bonds and resold to investors is highly technical and heavily lobbied. There are many ways for lawmakers to get it wrong economically but not so many ways to get it right politically.
So here’s the first thing to note about the new reform legislation from Sens. Mark Warner, D-Va., and Bob Corker, R-Tenn.: It’s good that someone’s willing to try. Both senators, and their six co-sponsors from both parties, know that the country can’t return to the Fannie-Freddie model, which disastrously privatized profits and socialized risks. Also, the recent housing upturn has started to produce profits for Fannie and Freddie, and hence for the government. The time to start unwinding and replacing them is now — before Congress develops an irreversible dependence on this deceptively easy source of cash.
Fannie and Freddie failed so spectacularly — and, before that, distorted capital allocation so insidiously — that one might well ask why Congress can’t just wind them up and let the private sector fend for itself. There might be less liquidity for mortgages, and the 30-year fixed-rate loan might become an endangered species — as opposed to the pseudo-constitutional right home buyers and sellers have been conditioned to expect. On the other hand, who knows what innovations a free market might produce?
In an obvious bow to political reality, the bill’s authors don’t go that route. Instead, they offer a form of government intervention intended to bolster liquidity as Fannie and Freddie did — but with the risks to the public and private sectors better defined and shifted toward the latter.
Private investors would bundle home loans into securities and then pay a new Federal Mortgage Insurance Corp. to protect them against catastrophic losses. To qualify for the protection, securitizers would put up 10 cents of their own money for every dollar of risk. Government would cover losses only above that stake, drawing on the accumulated insurance fees. If that much skin in the game had been required under Fannie and Freddie, the bill’s authors say, there would have been no need for a bailout. As for affordable housing goals, those would be replaced by a dedicated fund, financed by a user fee for securitizers.
This would be more transparent than the old system. Instead of implicitly guaranteeing the liabilities of two entities — Fannie and Freddie — whose accounting practices, capitalization and management were relatively difficult to assess, the government would be openly guaranteeing assets — mortgages, ultimately — whose risks can be more readily measured.
The problem will be deciding how much government charges for this service and whether that fee is sufficient to account for risk and protect taxpayers. The proposal’s heavy capital requirements compensate, but over time the new corporation would come under heavy pressure to reduce its fees or relax its standards, or both, in the name of promoting homeownership or some other worthy cause. A system like the one Messrs. Warner and Corker propose could succeed only if it includes abundant checks and balances against that danger. For now it’s enough to say that their bill is a serious proposal for a serious issue.
