Johnson-Crapo Bill: Flawed Resolution to an Interminable Situation

The conservatorship of Fannie Mae and Freddie Mac is shaping up to be the longest-running show since “Miss Saigon.”

Delays in resolving what to do with the government-sponsored enterprises are now in their sixth year. With an additional five-year timeframe for implementation of reforms suggested by Sens. Tim Johnson, D-S.D., and Mike Crapo, R-Idaho, this spectacle could easily run as long as the musical performed on Broadway from 1991 to 2001.

And that’s assuming the Johnson-Crapo bill even gets passed this year. My colleague Victoria Finkle has reported in American Banker that the committee vote on GSE reform set for April 29 may get shoved back while Senate Banking Committee leaders Johnson and Crapo try to woo the more liberal Democratic members of the panel into voting yes.

In the meantime here’s some consideration of the key points of the proposed reform (neatly put together by Victoria in a GSE reform cheat sheet).

A New Regulator: Washington loves a bureaucracy, and the proposed Federal Mortgage Insurance Corp. would provide one. Wait, wouldn’t it replace the current regulator, the Federal Housing Finance Agency? No, the FHFA would continue as an autonomous unit inside the FMIC. My verdict? Bureaucracy bloat.

Industry analyst David Lykken, managing partner of Mortgage Banking Solutions in Austin, Texas, agrees with me. “It’s another layer of bureaucracy. People will have to build [the cost of new bureaucracy] into their [home] price.”

A New FDIC: FMIC is said to be modeled after the Federal Deposit Insurance Corp. That’s probably a good thing, but old hands will remember another federal insurance agency, the Federal Savings and Loan Insurance Corp. The FSLIC became badly insolvent during the savings and loan crisis and was merged into FDIC.

Lykken also takes little comfort in a new federal backstop. “It creates a false sense of security” that allows firms to rationalize more risky behavior, he says.

Taxpayers on the Hook: Who will pay if there is another catastrophic meltdown like the one in 2008? The federal government, i.e., taxpayers. Watch the private firms run for the hills if big trouble starts. Lykken: “The private sector gets the profits and the government is ultimately the backstop.”

MBS Insurance: Private insurers will be on the hook for 10% of losses. Who will cover the rest? See the above bullet point.

Lykken feels this part of the reform “needs to be re-worked. They need to spend more time on that,” as well as on the industry’s systemic problems, such as the Consumer Financial Protection Bureau’s “approaching regulation from a penalty viewpoint” instead of an attitude of “let’s reward good behavior.” He also thinks some smaller lenders “have an attitude of ‘too small to comply,'” fearing the cost of compliance will run them out of business.

Co-operative Structures: It’s probably a good idea for an MBS platform and a small lender mutual coop to provide a secondary market. There is plenty of precedent for this. The Federal Home Loan Bank System and the Farm Credit System are cooperatives (not to mention the credit unions).

The co-operative structure “has more merit than some other things” in the bill, Lykken says. “A shared risk environment is appropriate.”

Absence of Affordable Housing Standards: One of the key components of the current Freddie/Fannie structure is mandatory affordable housing goals. Why give this up? Who is government subsidy of the mortgage business supposed to benefit if not low- and moderate-income borrowers? A proposed Market Access Fund presumably will take up some of the slack, but affordable housing could well go by the wayside.

Lykken sees some short-term pain here but long term he is looking at a revival of a healthy market that will lift all boats, including affordable housing. “I think the bill is better than nothing. Dammit, do something!”

Tribal Housing Set-Aside: Good idea. $20 million a year is just a drop in the bucket against this enormous need.

Vertical Integration: Garth Graham, partner of the Stratmor Group in Fort Lauderdale, and a longtime mortgage banker, thinks passage of reform would be a boost to market liquidity but asks, “Is it too much in favor of big banks? I’m not sure.”

Under the proposal, he notes, “if you have sufficient capital, you’re able to be a guarantor and generate securities.” This would give the big banks the capability to originate and service the loans and guarantee the securities—a soup-to-nuts arrangement that he notes they never wanted Fannie Mae to have the power to do.

Shrink Wrap: My bit to add to the debate: I think the real way to lessen the taxpayers’ risk is to reduce the mortgage amounts the agencies will be able to buy or guarantee. This should also boost the expansion of the nonconforming market as it would give the private sector some more room to play in. This isn’t in the current bill, but maybe it should be.

I’m sure GSE reform will get sorted out by the time of the election. Which election, though, I’m not sure.

Mark Fogarty, Editor at Large at National Mortgage News, is starting a regular blog of analysis and commentary based on his 30 years covering the mortgage industry.