Last week we considered the need to reform the mortgage market by phasing out Fannie Mae and Freddie Mac. Today we explore a blueprint for eliminating them thoughtfully and systematically while allowing buyers, lenders and investors sufficient time to adapt to a more market-oriented environment.
In June, a bipartisan cadre from the Senate Banking Committee introduced the Housing Finance Reform and Taxpayer Protection Act of 2013, laying out a strategy for eliminating Fannie and Freddie in exchange for a sensible government mortgage insurance regime that will mitigate risk to taxpayers and encourage private lending. The bill, dubbed Corker-Warner in reference to its lead sponsors, Bob Corker, R-Tenn., and Mark Warner, D-Va., is a thoughtful starting point on the road to replacing the dysfunctional home loan apparatus in the U.S.
The Corker-Warner proposal mandates the winding down of the GSEs at a pace of 15 percent per year, gradual enough for markets to absorb. Central to the plan is the creation of a new agency, the Federal Mortgage Insurance Corp., which would provide an explicit government backstop for investors in the event of a catastrophic wave of defaults. The new FMIC would play a similar role to the FDIC in the banking sector, and would be capitalized with fees assessed to issuers of mortgage securities (not by tax revenue). The agency would also set minimum standards for mortgages eligible for government guarantee.
Importantly, the plan stipulates that the first 10 percent of losses (at a minimum) be absorbed by private investors, shielding taxpayers from future bailouts in all but the most extraordinary circumstances and imposing more market discipline upon the lending process.
The Corker-Warner bill contains two other little-noticed but important provisions. It directs the Comptroller General to report within eight years on the likely impacts of a full privatization of the mortgage market, and instructs the FMIC to propose legislation to that end. And critically, the bill repeals Fannie and Freddie’s mandatory housing goals which resulted in such tragic financial hardship for so many families enticed into buying homes beyond their means.
As with any major reform proposal, opponents are legion. Conservative think tanks decry the continued (albeit subordinated) federal guarantee, on the plausible grounds that any level of government backstop encourages market distortions and excessive risk-taking. Meanwhile, the U.S. House of Representatives has proposed an intellectually satisfying but un-passable plan that eliminates the GSEs but also ends any Government role in stabilizing the market during a crisis. This approach fails to recognize that the mortgage market is addicted to subsidies, and the American populace is unwilling to quit cold turkey.
On the left, advocates of further expansion of mortgage lending have not given up, despite the carnage still extant from the 30-year experiment in universal home ownership. They argue that market-determined lending rates will shut out large numbers of potential buyers from sharing in the American dream. This argument ignores the millions of families whose lives were disrupted when the last government-fueled boom turned to bust.
The bipartisan plan proffered by the Senate strikes a reasonable balance and can serve as the template for reform. It phases out the two federally-controlled Leviathans and properly places private investors on the front lines. It also creates a guarantor of last resort but requires investors to bankroll the new agency. And it lays out a gradual and achievable path toward greater privatization, with fewer distortions leading to spikes, crashes and collateral damage.
Chris Hopkins, CFA, is a vice president of Barnett and Co. in Chattanooga.