It has been five years since Fannie Mae and Freddie Mac, the government-sponsored enterprises, were taken over by the federal government. Since then, we have witnessed an academic debate over GSE reform that has swung between proposals for the elimination of any role for the government in the mortgage market (other than through the direct guarantee provided by the Federal Housing Administration, the U.S. Department of Veterans Affairs and the U.S. Department of Agriculture rural housing programs) and proposals for some form of continuing federal support for liquidity in the mortgage market. It is time for Congress to act. Our housing finance system is broken and in need of repair.
Regardless of which side of the GSE debate you take, the bipartisan Corker-Warner bill may be the key to unlocking legislative action on GSE reform. The bill may be a bridge between the advocates of a purely private market and those who favor some role for the federal government.
The Corker-Warner bill calls for the termination of the existing GSEs. Most agree that the hybrid public/private structure of the GSEs contributed to their failure. The bill provides that the GSEs should cease operations within five years of enactment. In the interim, the bill also addresses two other factors that complicated the mission of the GSEs: it would require a reduction in the size of the portfolios held by the GSEs, and it would eliminate the requirement for the GSEs to meet targeted housing goals.
The bill divides the current operations of the GSEs among several entities. Most importantly, the issuance of mortgage-backed securities and the first-loss guarantee on the performance of those securities would be assumed by many private sector companies not the government. This eliminates the "too big to fail" risk created by two GSEs. It also means these companies could fail without any cost to the taxpayers.
Under Corker-Warner, the government would assume a backstop insurance risk. The bill establishes a federally managed insurance fund to make principal and interest payments to mortgage-backed securities investors in the event that the losses on the mortgages collateralizing the securities exceed the losses guaranteed by the private sector. This "federal guarantee" undoubtedly will be one of the more controversial features of the bill since the federal government has a relatively poor record in designing guarantee programs that are actuarially sound. However, it was designed properly in the Ginnie Mae (Government National Mortgage Association) program.
There are, however, strong policy reasons for such a backstop federal guarantee. Without such a guarantee, the pool of investors for mortgage securities would shrink and the availability of mortgage financing, especially the 30-year mortgage, would diminish, perhaps dramatically. Also, the cost of an explicit federal guarantee can be calculated, and this avoids the mispricing of risk that existed with the implicit federal guarantee of GSE securities.
Moreover, the bill includes a number of provisions designed to minimize taxpayer exposure under the federal guarantee. Several of these provisions are patterned after the safeguards that Congress has imposed on the Federal Deposit Insurance Corp., which backstops bank deposits, and which has never resulted in any cost to taxpayers. These safeguards include a requirement that the mortgages collateralizing securities that carry the federal guarantee meet the new "ability-to-repay" underwriting standards mandated in the Dodd-Frank Act; that the private sector assume a 10% first-loss risk on the mortgage securities and that the private sector finance the federal fund that could be tapped to cover losses exceeding the 10% first-loss guarantee. Well-respected analysts including Phillip Swagel and Mark Zandi agree that the 10% first-loss coverage, alone, would have more than protected taxpayers during the recent financial crisis.
Admittedly, the bill is not perfect. The 10% first-loss requirement is excessive and would increase the cost of mortgage finance for consumers. Also, the bill creates a new bureau to oversee the mortgage market, and the powers granted to this new bureau, including its power to issue market standards without public comment, deserve serious review.
Nonetheless, the bill is a major step forward in the GSE reform debate. It provides for a transition away from the flawed GSE structure to a private system of housing finance and structures a role for the federal government that ensures a steady flow of reasonably priced mortgage credit without creating an undue risk to taxpayers.
The Corker-Warner bill is a serious contribution to the debate on reforming the housing finance market. We hope Congress will seriously evaluate and debate the proposal with the goal of producing final legislation that can create a strong system for the future.
John H. Dalton is president of the Housing Policy Council at the Financial Services Roundtable.