A Failed Model for GSE Reform
News regarding the housing market has turned somewhat sanguine as of late. Prices have significantly increased in what were previously highly depressed regions; increases in home construction, mortgage originations, and refinancing applications abound in monthly reports; and news headlines tout an emerging rebound. Housing expert Mark Zandi, in a Washington Post piece earlier this year, boldly suggested that "housing's renaissance could lead an economic recovery."
So it would seem the time is ripe for Congress to get to work reforming the nation's mortgage behemoths, Fannie Mae and Freddie Mac (collectively the GSEs) -- work left neglected by 2010's Dodd-Frank Act. Leading the way is a proposal by Sens. Mark Warner (D., Va.) and Bob Corker (R., Tenn.). While we commend Mssrs. Warner and Corker for taking head on the great unanswered question of financial reform, ultimately their proposal is weak sauce.
The main thrust of their proposal is to eliminate Fannie and Freddie, and in their place create a new independent agency called the Federal Mortgage Insurance Company, which is meant to standardize mortgage securitization, provide catastrophic reinsurance for those securities, and, most importantly, operate a "Mortgage Insurance Fund" (MIF). Said to be modeled after the FDIC's Deposit Insurance Fund, which covers deposits in the case of bank failure and is paid for by assessments on those same institutions, the MIF would consist of guaranty fees and other payments by mortgage lenders to the new agency.
Seems reasonable.
But the relevant antecedent isn't the FDIC, but rather the Federal Savings and Loan Insurance Corporation (FSLIC), the federal insurance company that was charged with maintaining a fund to cover the deposits of savings & loans (aka thrifts) -- until the S&L crisis hit and the company was abolished.
S&Ls did the lion's share of mortgage lending and holding from the early 1950s through the late 1980s; at one point, they held over 70 percent of all single-family mortgage debt. The FSLIC was repeatedly bailed out by taxpayers in the '80s until finally, in 1989, it was deemed to be beyond saving.
The S&Ls' share of mortgage debt rapidly declined throughout the '80s and '90s, with commercial banks never straying above 22 percent of market share over the last 60 years. But as the S&Ls receded, the GSEs moved in almost perfect lockstep to pick up the slack:
Policymakers should be acutely concerned about creating another federal insurance program tied to such a large share of mortgage market.
The bill also includes provisions for affordable and low-income housing objectives. Putting aside the potential merits of such programs, they should be funded through the normal appropriations process, in a transparent and on-budget manner. Such programs already exist at the Department of Housing and Urban Development, the Federal Housing Administration, and elsewhere in the federal budget. Thus, off-balance-sheet affordable-housing goals, such as those in the bill, are unnecessary and a repeat of Fannie Mae and Freddie Mac's problem.
And where are the protections for taxpayers? The proposed Federal Mortgage Insurance Corporation covers up to 90 percent of potential losses with a minimum down payment of only 5 percent. Fannie Mae was recently requiring a minimum down payment of 3 percent and private mortgage insurance coverage down to 80 percent, so Corker-Warner doesn't do enough to change the status quo.
As former Freddie Mac economist Kevin Villani notes, these protections under Coker-Warner are way too weak to be sustainable, even with the proposed, but politically vulnerable, 5 percent capital requirement that some will argue is too high.
Moreover, the bill presumes a need to preserve the 30-year, fixed-rate mortgage, a product that often is not in the best interest of the borrower. For instance, a 5/1 ARM -- an adjustable-rate mortgage that offers a low rate for five years, followed by a rate that changes annually to reflect fluctuations in the market -- could save borrowers thousands of dollars during the initial five-year period, with various options to refinance thereafter.
Corker-Warner replaces the GSEs with a potentially riskier model and maintains the same features, such as too little capital and too little down payment, that almost crashed the financial system. Meet the new boss, same as the old boss.
Satya Thallam is director of financial-services policy at the American Action Forum. Anthony Sanders is distinguished professor of real-estate finance at George Mason University.
