America's Housing Finance Reform Plan Is Much Worse Than People Realize
A rare area of agreement about the financial crisis of 2008 is that Fannie Mae and Freddie Mac were at the core of the meltdown and are in urgent need of reform. On March 16th the leading Republican and Democratic members of the key Senate Banking Committee belatedly released a plan for restructuring the two publicly traded mortgage giants.
The plan has received widespread attention in part because it appears to address the most evident problems of Fannie and Freddie and because it is deemed likely to be approved by Congress. Yet neither of these assumptions, on deeper examination, seems to be true.
To satisfy those who want low-priced mortgages on terms that private markets would never endorse, the plan makes explicit the government guarantee on debt which had been implicit for Fannie and Freddie. This would lower the interest rate on high-risk loans, while obscuring the cost of the subsidy.
To placate those who worry that this in turn would leave the government stuck with mountains of dud loans, a 10% capital cushion must be provided by investors to absorb initial losses.
A fee of 0.1% would be charged on all mortgage-backed bonds, with the proceeds going to three funds, two pre-existing, that will provide subsidies for housing. An as-yet undetermined insurance charge will be levied on top. The result, said Mike Crapo, the ranking Republican senator on the committee, "would be a strong step forward" to fixing "our flawed housing system".
If only, say critics, who include investors and both friends and foes of Fannie and Freddie. The first objection is that the law would create an unwieldy bureaucracy, with a regulator atop other entities devoted to overseeing functions such as syndicating loans or bundling the loans of small banks.
When the plan was announced, the price of shares in Fannie and Freddie, which account for about two-thirds of the mortgage market, did not budge at first. Then they tanked--presumably because investors reached page 387 of the 442-page text and found enshrined in legislation an earlier 2012 order by the Treasury that expropriated from private investors all profits made by Fannie and Freddie.
The move is unlikely to help attract the private money needed to supply the 10% in equity underpinning bonds issued under the new plan.
Opponents of Fannie and Freddie contend that the two played a key role in the crisis by encouraging the issuance of loans with tiny down payments through a benign-sounding "affordable housing" mandate. Nothing much has changed. Under the new plan, downpayments of as little as 3.5% of the loan value would be permitted.
Strewn through the proposed law are words such as "affordable", "equal access" and "underserved communities", which suggest that lending decisions will be based on political rather than credit criteria. "The result", says Edward Pinto of the American Enterprise Institute, a think-tank, "will be risky lending for those least able to cope."
The underlying problem with the new plan is that, like Fannie and Freddie before it, it tries to reconcile two conflicting goals: protecting the financial system and providing low-cost housing loans to favoured groups. A better approach would be to handle these goals separately and explicitly.
Click here to subscribe to The Economist
