A New Consensus?
September 11, 2011
As Washington has sweltered under a record heat wave this spring and summer, another thaw of sorts has been taking place on Capitol Hill. After two years of intensely partisan and polarizing positioning around the future of Fannie Mae and Freddie Mac, two bi-partisan proposals have created a new front that could signal a more hopeful future for the debate.
The two bills are HR 2143 sponsored by California Republican Gary Miller and New York Democrat Carolyn McCarthy and HR 1859 sponsored by California Republican John Campbell and Michigan Democrat Gary Peters are very different in key respects.
While the bills take radically different paths to a new market paradigm, both start from the premise that the federal government should continue to play a key role in the nation's mortgage system. Both bills would authorize government support for mortgage securities. Both would create new entities to succeed the failed mortgage giants Fannie Mae and Freddie Mac. And both would charge a new fee to cover the cost of an explicit and limited guarantee of mortgage securities - not entities that issue them. These common elements establish a new anchor for the debates to come in the House and Senate over the future of the mortgage finance system.
Until now, the only comprehensive Republican-backed proposal for a post-GSE world has been Rep. Jeb Hensarling's HR 1182, which would wind down Fannie and Freddie and leave no enduring federal role in the conventional mortgage market. Other Republican members of the House Financial Services Committee have introduced a flurry of bills that each attacks a different aspect of the GSEs' conservatorship and collectively endorse a much more constrained federal role. Rep. Scott Garrett's Capital Markets subcommittee has held hearings and mark-ups of these bills, but the full Committee has yet to schedule time to consider them. Hensarling's bill, and the adamant opposition to any continuing federal support for mortgage finance that it symbolizes, has support from Republican freshman back benchers, and surely will claim vocal support once the full Committee begins considering options.
The Miller-McCarthy bill would establish a publicly owned and operated "credit facility" for securitizing loans for both ownership and rental housing. The entity would absorb the current operations of Fannie Mae and Freddie Mac; those companies would be wound down through the current conservatorship. The new facility would maintain a portfolio, principally for enabling the facility to be a countercyclical force in the market, to modify delinquent and defaulted loans it has guaranteed, and to carry out specialized multifamily rental housing finance. The new facility would be governed by an independent board, and regulated by the current GSE regulator, the Federal Housing Finance Agency (FHFA). Although owned and operated by the US government, the facility's workers would neither be government employees, nor subject to its normal workplace and compensation rules. The facility would charge two separate fees for its securities - one to provide a top level guarantee, much like Fannie and Freddie historically have done, and a second to finance a new insurance fund to provide a catastrophic back-up guarantee. As with Fannie and Freddie, loans with less than 20 percent borrower equity would have to have further credit support, either through private mortgage insurance or participation by the originating lender.
The Campbell-Peters bill would authorize the establishment of new, chartered mortgage guarantors backed by private capital to guarantee securities for both rental and ownership. These entities could be owned by any financial services entity, including through lender cooperatives. While the new entities could operate portfolios, they would do so without any federal support. Their securities, meanwhile, would enjoy a catastrophic guarantee that would be financed through a fee paid by consumers. While this guarantee would protect investors in the mortgage backed securities issued by the new entities in the event their own capital is exhausted by losses, it would extend no protection to the investors or bondholders of the new entities. The entities would be chartered and regulated by the FHFA, and like Miller-McCarthy, would require additional credit support for loans with less than 20 percent borrower equity.
The sponsors' common embrace of a federal role in supporting the housing finance market is important because much of the debate around mortgage finance reform has hinged exactly on this point. Free-marketeers and conservatives generally have argued against any continuing federal role in the markets outside of FHA. According to these advocates, government involvement in the housing market was a leading cause of the mortgage crisis. In this narrative, increasing levels of directly and implicitly subsidized federal involvement in the housing markets since the Great Depression led to the catastrophic run up in housing prices in the 2000's, the rise of subprime lending, inflated house prices and the credit bust of 2007-08. They argue that only when the private market is allowed to operate without government involvement will markets stabilize.
The other side of this polarized debate has argued that market and regulatory failures in the early 2000's led to an explosion of private label mortgage securities fueled by an unregulated "originate to sell" underwriting model that fueled a race to the bottom in standards as originators, lenders, securitizers and investors sought ever greater volumes of supposedly safe and high-yielding mortgage securities. In this model, Fannie's and Freddie's market dominance - and the underwriting standards that had long dominated the market - were outrun by the private securities market. Their singular focus on residential mortgages and their very thin capital requirements put them in extreme jeopardy when the market collapsed, and their peculiar private ownership model led them to try to follow the stampeding herd into riskier loans in order to regain market share lost to private label securities, leading to catastrophic losses and government takeover. This narrative concludes that while the private ownership/implicit federal guarantee model of the GSEs is not sustainable any longer, a more constrained and focused federal role remains critical to ensuring liquidity, stability, and access to affordable and sustainable mortgage credit.
It looked like the debate over housing finance reform would turn into a straight-up death match between these views. But the introduction of these two bills has changed that dynamic. Neither bill is ready for prime time; they are both more like conceptual sketches than working blueprints. Progressives will find fault with both of these proposals - neither makes a significant effort to assure these new entities serve all communities and households, avoid "creaming" the markets, or extend credit to otherwise underserved areas. Conservatives will oppose the bills' fundamental embrace of a federal role. But that agreement in the bills to a fundamental support for a government role and the use of an explicit federal guarantee that is priced and paid for means that the debate's center of gravity has shifted significantly away from the bipolar extremes of only a few months ago.
There is little prospect of either of these bills moving forward any time in the near future. And it's likely that a significant portion of senior committee leaders and restive back benchers will continue to push for the elimination of federal support in mortgage markets.
But Miller, McCarthy, Campbell and Peters have vowed to press for hearings on their bills, and to bring them up whenever GSE reform is discussed in the House Financial Services Committee. The fact that Republicans and Democrats are beginning to talk about the same fundamental premises and are collaborating together to design a new approach based on them is notable in its own right as a bright spot in an otherwise polarized landscape. It gives the Administration more room to maneuver as it readies Version 2.0 of its own proposals. It will shift the debate's middle ground further to the left than seemed likely only a few months ago.