I’m a little surprised at the overly coded reporting at the New York Times and particularly the Wall Street Journal, where Nick Timiraos provides top-notch coverage on the mortgage beat, on the implications of the failure of a widely-touted, Administration-backed GSE reform bill to get out of the Senate Banking Committee. Basically, it confirms what I’ve long believed but refrained from writing about, namely, that government sponsored enterprise, aka, GSE reform, was not going to get done in this session of Congress.
Let me give the high level version of why GSE reform was a pretty sure bet not to happen and some key details. In general, legislation does not get passed, particularly given bipatisan rancor, unless there is a source of pressure. Even though Fannie and Freddie are hated by the right, the fact is that they are an absolutely critical to the functioning of the mortgage market, particularly since the banking and securitization mafia succeeded in blocking meaningful securitization reform. That meant there’s no meaningful alternative to government guaranteed mortgages, at least on any pricing that wouldn’t kill the not-terribly-robust housing market. The private market is only 10% or so of total originations post crisis, and it’s almost entirely extremely high quality jumbo mortgages (those with mortgage balances too large to qualify for Fannie and Freddie insurance).
And Fannie and Freddie are profitable right now, so there’s no impetus to make changes.
Perhaps as important, despite a nominally bipartisan bill being tabled in the Senate (the aforementioned Johnson-Crapo), there’s no consensus on what to do about the GSEs. Most Republicans profess open hatred of government support of mortgage finance. The House passed a so-called PATH Act last year which was never going to get anywhere, mainly because it proposed virtually eliminating the Federal guarantee of mortgages in five years. (Let me be clear that in the abstract I’m deeply opposed to the inefficiency of using housing finance to implement housing policy, but you have to start with existing conditions, and any effort to roll back the Federal guarantee is a fraught operation. There are ways to cut it back, but this idea is nuts). And it has other charming features, as Dave Dayen discussed at length last year in House Republican GSE Bill Would Codify MERS, Pre-Empt Private Property Rights. This bill basically allowed House Republicans to have their cake and eat it too: they could tell the more rabid members of their base that they were opposed to government subsidies for housing, but by supporting such a radical bill that would never get passed, not actually rattle the members of the mortgage-industrial complex (like Republican brokers and developers) in their constituency.
So the House and the Senate were never going to see eye to eye with PATH Act. But then we get to the Johnson-Crapo headfake. Josh Rosner kneecapped this GSE “reform” proposal in a Wall Street op-ed earlier this year. Some key points:
Unfortunately, the bill replaces Fannie and Freddie with an untold number of new government-sponsored enterprises by handing a massive taxpayer backstop to the nation’s largest banks. These banks will also profit handsomely from large mortgage volumes as a result of the bill….
Rather than fix these problems, legislators seek to demolish the current mortgage market and build, from scratch, a new system that makes things worse. They put at its center a new regulator, the Federal Mortgage Insurance Corporation, with a fundamentally conflicted mission—combining safety and soundness, affordable-housing goals and consumer protection. The bill will have the effect of increasing rather than reducing the concentration of lending in the hands of a few large banks. Under the legislation the government will also sponsor mortgage aggregators, insurance entites and a mutually owned securitization platform.
Our largest financial firms will use their public homeownership mission to push for eased lending standards. In good times lenders and their shareholders will enjoy the profits generated by higher mortgage volumes, and in bad times the public will again be stuck holding the bag. Sound familiar?
To avoid public outcry, Messrs. Johnson and Crapo contend that private capital will take the first 10% of losses ahead of the government. But where is that capital coming from? They say, without basis, that the necessary $500 billion of “required” private capital will appear.
Now in fact, the 10% loss provision in theory should be doable because even the very worst Fannie and Freddie securitization lost only 5%. Yes, you read that correctly. Remember, the ginromous losses that the GSEs took were almost entirely due to bad investments. They invested their proceeds from their insurance fees in subprime loans and bonds. But on their securitizations, losses were typically in the 2% range on issues in the period shortly before the crisis. That was still bigger than the loss levels they had anticipated and they were way too thinly capitalized, so they came up short on that side too, but the overwhelming majority of the losses were due to bad investments.
But Rosner’s point is still valid because 10% is such an ample cushion that the banks would be certain to finesse it. And why should we concentrating systemic risk by turning even more government backstopped profit sources over to them?
It was also disturbing to see the Administration throw its weight behind another gimmie to the banks when there was a sound reform propose from House Financial Services Committee ranking member Maxine Waters. A short summary in the Wall Street Journal:
One key difference between Ms. Waters’ bill and the proposal from Sens. Tim Johnson (D., S.D.) and Mike Crapo (R., Idaho): the Waters proposal would create a single entity in charge of issuing and guaranteeing mortgages, while the Johnson-Crapo proposal would allow a series of different private entities to compete for that business. The Waters proposal would also require the lender co-op to maintain a 5% capital buffer, compared to 10% required of guarantors in the Johnson-Crapo draft. Both proposals would wind down Fannie and Freddie over many years…
The Waters bill isn’t the first to propose a mutually-owned successor to Fannie and Freddie. The bill largely reflects an earlier blueprint advanced by the Center for Responsible Lending, a consumer advocacy group. The New York Federal Reserve Bank has also outlined a mutually-owned utility structure to replace Fannie and Freddie.
Advocates of mutual ownership say it would remove one of the key tensions that drove Fannie and Freddie to relax their lending standards as the housing market overheated.
You pretty much never see the New York Fed and a respected consumer advocacy group agree on anything. The Waters proposal was tantamount to turning the GSEs into a utility, an idea we’ve advocated repeatedly. And it also gave every member that did business with the utility one vote, which means community banks would have as much say as JP Morgan.
So what happened yesterday? As the New York Times reports, while Johnson-Crapo had enough votes to pass in the Senate Banking Committee (meaning at least 12 out of its 22 members), if a bill comes out of committee with less that solid support (which in this case would mean at least 17 or 18 votes), it is seen as damaged goods. So even though the Times and Journal reported the vote as “delayed,” this really means the bill is unlikely to get out of committee.
What I am told is the the liberals killed it. The reform-minded Senate Dems are of the view that securitization has not been fixed, and they do not want to turn this franchise over to banks until the servicers have been forced to clean up their collective act. Given the mess of the underlying systems, I’m not sure how this happens, but there is no way it will ever get done absent continued pressure.
Former representative Brad Miller wrote an op-ed in Politico three days ago that highlighted the conflicts of interest in the mortgage servicing model, and it’s a great recap of the fundamental problems in servicing that we’ve discussed at length since 2010. I’m told by insiders on the Hill that Sherrod Brown used the Miller piece to suggest amendments to Johnson-Crapo that would have addresses some of the issues that Miller raised, and also brought the bill closer to the one Maxine Waters proposed. That was apparently not in line with what the stealth-giveaway-to the-banks crowd had in mind, and that appears to have deep-sixed a bill that never should have seen the light of day in the first place.
So while it’s good to see that a phony GSE reform effort has stalled, it’s still disappointing to see that the Administration isn’t being called out for backing such a garbage barge. But I suppose we can take cold comfort in the idea that this failure shows that Obama’s power is falling fast.