GSE Reform Dead for Now

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.

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  1. allcoppedout

    The man called Crapo – you just can’t make this stuff up! I fancy serious black hole creation in F & F. We have no evidence anyone can read the accounts and there is probably an asset price crunch coming along with discovery the structural job market is much worse than claimed. It looks like the Coop takeover of Britannia here, but super-sized to systemic destruction. Loot seems to be put up to salt the mine, yet those who would normally be the suckers are in on the scam. Any sex addicted, snorting Methodist ministers involved?

  2. financial matters

    Good to see the position of the New York Fed. Would be good to see more of these type of recommendations getting broader support…

    “”People ask, “Why can the Federal Reserve spend and lend trillions to save Wall Street banks but will not do the same to rescue the real economy?” That is a good question. At this troubled hour, the Federal Reserve should find the nerve to abandon “failed paradigms” and to use its broad powers to serve a broader conception of the public interest. If we are to expand the Fed’s authority, it should be done to further the public purpose.

    The Fed belatedly turned its attention to the foreclosure crisis when it realized that the housing sector, clogged with millions of failed mortgages and vacant houses, was a big part of why Bernanke’s monetary policy has failed to generate robust recovery. Housing, of course, is an issue that belongs to the fiscal side of government, but the Fed can help out because its “dual mandate” in law requires monetary policy to support both maximum employment and stable prices. If the housing market does not get well, the Fed reasoned, there will be no recovery.

    Though it seemed out of character for the central bank, the Fed staged its version of a media blitz on behalf of troubled homeowners. In the span of seven days in January 2012, two governors from the Federal Reserve Board in Washington and three presidents from the twelve regional Federal Reserve Banks delivered strong speeches on how to revive housing. They asked the elected politicians to consider a broad campaign to reduce the principal owed by the 11 million homeowners who are underwater, owing more on their mortgages than their homes are worth. Most of them cannot sell and cannot keep up with their payments, and are thus doomed to foreclosure.

    All this was explained in the White Paper Bernanke sent to Capitol Hill, which detailed why cleaning up the housing mess is necessary for a “quicker and more vigorous recovery.”139 Housing advocates and community activists had been telling the central bank the same thing since the collapse began. Fed governors listened politely but had never responded. If nothing changes, the White Paper warned, market adjustments “will take longer and incur more deadweight losses, pushing house prices still lower and thereby prolonging the downward pressure on the wealth of current homeowners and the resultant drag on the economy at large.”

    The White Paper was hedged with qualifiers, but it read like a handbook for recovery. A prime mover behind the initiative was William Dudley, president of the New York Fed. Dudley suggested $15 billion in bridge loans to tide over unemployed homeowners. He urged Fannie Mae and Freddie Mac, the two government-sponsored enterprises (GSEs) now in conservatorship, to reduce outstanding balances on delinquent loans—which most likely will never be repaid anyway. “I am uncomfortable with the notion that ‘underwater’ borrowers who owe more on their mortgages than their homes are worth should have to go delinquent before they have a chance of securing a reduction in their mortgage debt,” Dudley told an audience of New Jersey bankers in January.140 The standard objection to debt reduction is “moral hazard”—the fear that it will encourage bad behavior by other debtors. Dudley dismissed this as overblown. Most people in trouble, he said, are victims of bad luck—they bought their house at the peak of market prices or they became unemployed through no fault of their own. (He might have added that many of them are also victims of lender fraud.) “Punishing such misfortune accomplishes little,” he said.

    Dudley’s remark suggests a different tone at the Fed, one more sensitive to the human dimensions of economic crisis. Governor Sarah Bloom Raskin, who was appointed to the Federal Reserve Board by President Obama, delivered an unusually caustic message to bankers last year. She is pushing substantive penalties for banking-sector abuses—the regulatory diligence neglected by the Greenspan Fed. “In the housing sector, we traveled a very low road that had nothing to do with looking out for the greater good,” Raskin declared. “On the contrary, there were too many people in all of the functional component parts—mortgage brokers, loan originators, loan securitizers, subprime lenders, Wall Street investment bankers and rating agencies—who were interested only in making their own fast profits…Now it is time to pay back the American citizenry in full.”141

    The foreclosure mess, the Fed noted, hurts innocent bystanders when their neighborhoods are ruined by other people’s failure. Towns burdened by lots of empty houses lose

    139 See Ben S. Bernanke, “The US Housing Market: Current Conditions and Policy Considerations,” White Paper, Federal Reserve Board, January 4, 2012. 140 William C. Dudley, “Housing and the Economic Recovery,” Remarks at the New Jersey Bankers Association Economic Forum, Iselin, NJ, January 6, 2012. 141 Sarah Bloom Raskin, “Putting the Low Road Behind Us,” Speech at the 2011 Midwinter Housing Finance Conference, Park City, UT, February 11, 2011.

    property-tax revenue needed to sustain public services. The foreclosure process piles up “deadweight losses” in which nobody wins, not even bankers. Mortgage relief, on the other hand, in effect redistributes income and wealth from creditors to debtors. “Modifying an existing mortgage—by extending the term, reducing the interest rate, or reducing principal—can be a mechanism for distributing some of a homeowner’s loss (for example, from falling house prices or reduced income) to lenders, guarantors, investors, and, in some cases, taxpayers,” the Fed document explained. Both the lender and the borrower can gain from reducing the size of an underwater mortgage, the Fed asserted. “Because foreclosures are so costly, some loan modifications can benefit all parties concerned, even if the borrower is making reduced payments.”142″”

  3. Jim Haygood

    ‘Rather than fix these problems, legislators seek to demolish the current [system] and build, from scratch, a new system that makes things worse.’

    This is, by definition, what every bipartisan ‘reform’ bill accomplishes [e.g., Obamacare].

    Actual reform is what the Depublicrat party is there to prevent at all costs.

  4. NotTimothyGeithner

    Have we reached critical mass where the administration can’t be connected to anything for it to pass, no matter how seemingly innocuous? The Senators have passed hideous bills in the recent pass, so I doubt the contents bothered them as much as association with the White House.

  5. Klassy

    Is this a typo? I was just wondering if you meant “vapid” or “radical”:
    “This bill basically allowed House Republicans to have their cake and eat it too: they could tell the more rapid members of their base”
    At any rate, very glad to see this bill die. It seemed like the worst of all possible worlds.

    1. Yves Smith Post author


      Fixing, thanks!

      Hatred of Fannie and Freddie is rabid among Republicans.

  6. Fair Economist

    Fannie and Freddie were the *least* problematic part of the mortgage market before 2008 – they had significantly lower default rates that the rest of the market. They only had problems because the free market went so nuts during the housing bubble. I’m sure they could be improved, but they’re fine as is. It’s the non-GSE side that needs reform.

  7. Vatch

    Perhaps “rabid” was intended. I didn’t write the article, but I do have plenty of experience creating typographical errors!

  8. allcoppedout

    With estimates of a $80 – 200 billion bailout coming on top of the $185 billion already gone, what hope can there be for F & F as a leveraged bet on the one way speed of house prices? We’re being had upside down and over. The report into our of our tiny bank mergers cost £4.5 million for something a current commercial fraud cop could have done in a day. Our Coop Bank didn’t visit the assets and nor did the accountants of two big firms.

    I see no answers to F & F as long as the cops are not sent in with a new public scutiny prosecution framework. Across public scrutiny we are merely paying lawyers for more cover-up.

  9. DolleyMadison

    Have any of you heard of these people? They are harrassing a friend -demanding copies of her w2s from the year she got her loan and copies of her settlement papers…first offered her money now threatening to go to her employers ( not sure why) and making other thinly vieled “the authorities will get you” type threats. Sounds like the fight buyback demands madeby GSEs.

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