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Time to Stop Taking Non-Serious Fannie Mae Reform Plans Seriously

As the tenth anniversary of the financial crisis that nearly brought down the global economy nears, it is astounding that ill-conceived experiments that would expose taxpayers to the risk of future bailouts are still being debated. But that is exactly what is going on.

Mortgage Bankers Association President David Stevens earnestly hopes Congress will agree to an explicit federal guarantee for mortgage backed securities (MBS) offered by so-called guarantors that would be nurtured to compete with and eventually supplant Fannie Mae and Freddie Mac in the secondary mortgage market. These guarantors are at the basis of the MBA’s vision for housing finance reform, which tracks closely with legislation awaiting formal introduction by Sen. Bob Corker, R-TN, and Sen. Mark Warner, D-VA.

Bruce Berkowitz

In a March 15 commentary in American Banker, Stevens made an interesting distinction. The MBA favors an explicit government guarantee on MBS but opposes such a government guarantee for the actual guarantors who issue the securities. He sees government backing for the MBS as a way to create a more level playing field where institutions of all sizes could compete with vitality and innovation, benefitting consumers and increasing liquidity in the secondary mortgage market. At the same time, he contends that providing a government guarantee for the institutions themselves would be “nonsensical” and harm taxpayers.

But is it possible to have one’s proverbial cake and eat it too? Guarantors and their products cannot really be so easily separated. Should the value of those MBS take a sudden nose-dive, a taxpayer-funded bailout would be necessary and that scenario is not far-fetched. As Norbert Michel and Josh Rosner suggested in a piece in the American Banker, in order to reduce risks to taxpayers it would be better to reduce the government’s guarantees in the mortgage market – not expand it.

Stevens and his compatriots theorize that extending a full-faith U.S. government guarantee while simultaneously protecting taxpayers could be accomplished with a “mortgage insurance fund” created by banks, similar to the FDIC. That might sound reasonable but the way the explicit government guarantee is envisioned in the MBA’s plan, the big banks would have incentive to retain too little reserve capital. After all, if the U.S. government stands behind the MBS, they can afford to gamble a little. The 2008 financial crisis proved the government will clean up messes the free market can occasionally create.  So much for lessons learned.

Michel and Rosner also pointed out if the large financial institutions that would issue the vast majority of the MBS in the MBA’s plan were to get into trouble simultaneously – a strong possibility – then the government would have to choose between bailing out investors in those government-guaranteed MBS or depositors in those banks. There are other aspects of the MBA plan that raise legitimate questions about whether it is feasible or if it represents a vast improvement over a system anchored by reformed, streamlined, well-capitalized, and well-regulated Fannie Mae and Freddie Mac.

During a three-day online “Housing Finance Reform Policy Debate” hosted by the Urban Institute last week, participants delved into these and other issues. Tim Howard, a former Fannie Mae CFO, who was among the panelists, summed up plans to get rid of Fannie and Freddie in a blog post afterward, writing, “There is no policy reason to replace them with an untested alternative; they should be allowed to recapitalize to new risk-based standards, be given utility-like return limits and made subject to tighter regulation, and be released from conservatorship.”

The draft Corker-Warner measure goes in the opposite direction. In Howard’s view, the legislation is “devoid of details” and “silent on credit guarantor capital requirements,” leaving FHFA Director Mel Watt’s eventual successor the task of figuring out how exactly the new multi-guarantor system would work. “That is extremely risky,” Howard wrote. He sees a detailed blueprint from Moelis & Company as providing a way for Treasury to move past the current state of limbo without the need for legislation.

That plan recognizes a key fact: The GSEs have long since paid back taxpayers for the principal $187.5 billion – as well as the 10 percent interest required by law. If Treasury were to keep that money and raise $75 to $100 billion by exercising warrants for 79.9% of the GSEs’ common stock, that would be the first step to liberating the GSEs from the conservatorship and ending the quarterly raid on their revenue in effect since 2012 with the Net Worth Sweep. This in turn would enable the GSEs to attract additional investors and raise tens of billions of dollars in additional capital to operate in a truly “sound and solvent” manner as the law requires. With tough capital requirements and prudent regulatory standards envisioned by the plan, there would be no need for open-ended government backstop, just a limited, explicit government guarantee for systemic catastrophes.

The consensus among participants at the Urban Institute event was that the conservatorship could easily last several more years. That would be an unnecessary disaster. The impasse on GSE reform cannot be helping the housing market. True, home prices are going up, particularly in upscale markets. That is great if you already own a home and are rich. But if you are an average worker looking to finance a home now or in the near future, the recent sharp drop in in new housing starts, tighter credit, and uncertainty about the fate of the 30-year mortgage are probably creating a chilling effect on your plans. In the aggregate, anemia in the housing sector, which makes up close to 20 percent of the GDP, will ensure the desired annual growth of three percent remains a pipe dream in the minds of politicians.

Amid all the op-ed battles and policy forums, Congress keeps failing to come up with feasible ideas and the forgotten Americans championed in 2016 keep getting forgotten. Officials at FHFA and the Treasury Department have all the statutory authority they need to end the conservatorship, make sure the GSEs have ample reserve capital, and establish long-term stability in the housing finance system. They should use that authority and act before the economy slips into the next recession.