The Johnson-Crapo bill to wind down Fannie Mae and Freddie Mac is big news — but is it much ado about nothing?

New bill on the block

Following the reform of Fannie Mae and Freddie Mac is like watching a never-ending Netflix marathon of a show you love to hate. We may, however, finally have made it to the final season.

A bipartisan bill to reform the government-sponsored enterprises (GSEs) is garnering lots of attention on Capitol Hill and around the real estate brokerage water coolers. Introduced by Chairman of the Senate Banking Committee, Tim Johnson (D) and ranking member, Mike Crapo (R), the bill phases out Fannie Mae and Freddie Mac and replaces them with a new entity, the Federal Mortgage Insurance Corporation (FMIC).

The FMIC is modeled after the Federal Deposit Insurance Corporation (FDIC). In other words, Fannie Mae and Freddie Mac are likely to be replaced by a federal entity extending an explicit government guarantee. Thus all investors in the secondary mortgage market would enjoy protections similar to the ones the FDIC affords all depositors in the U.S.

A 400-page bill in six easy steps

But we’re talking about Congress here, so it won’t be quite that simple. Instead of installing a federal agency to guarantee (read: subsidize) secondary mortgage market investment, the bill attempts to build bi-partisan consensus with what it calls a “10-point plan.”

We’ve summed their plan up in six points:

  1. Facilitate a smooth transition from the GSEs to the FMIC by implementing definable benchmarks and a clear timeline.
  2. Maintain loan limits and underwriting standards during the transition in order to ensure market liquidity.
  3. Create an insurance fund to protect taxpayers from having to fund eventual bailouts.
  4. Explicitly guarantee a maximum of 10% of investor losses, ostensibly forcing more private skin in the game.
  5. Only back loans that meet the qualified mortgage (QM) standards.
  6. Eliminate affordable housing goals and replace them with affordable housing funds paid for by guarantee fees.

On board yet?

Obamacare for the housing market

When the bill first made its way down the political pike, many cheered its appearance as a reasonable compromise in a contentious debate that has been raging since at least 2008. Those on the left were obviously pleased with the term “explicit government guarantee.” Those on the right would finally witness the evisceration of affordable housing laws and the ultimate demise of two of the largest publicly funded entities in the U.S.

The bill has yet to pass in either house of Congress, but the political war has begun. Both sides are denouncing its flaws, and it’s already earned the nickname of the “Affordable Care Act of the housing industry.”

There is some truth to this moniker. Not just because of its contentious and politically polarizing nature, but also due to the attempt at compromise, which is similar to the public-private Frankenstein’s monster that is Obamacare.

Inherent flaws

Obamacare is an undeniable mess, regardless of any principled arguments one may make. It appears Fannie Mae and Freddie Mac’s reform is following suit. The compromises taking place have more to do with satisfying political myths and misunderstandings than figuring out what really works.

For instance, the push to eliminate affordable housing policies, such as the Carter-era Community Reinvestment Act, comes from the completely debunked belief that these programs caused the subprime mortgage crisis. Equally erroneous is the belief that an “explicit guarantee” is any more effectual than the implicit guarantee already in place. A guarantee is a guarantee, and our existing guarantees have created the most profitable and highest velocity mortgage market in the world.

In fact, the explicit guarantee under the proposal is extremely conservative, covering only 10% of an investor’s losses. Many rightly argue such a meager guarantee will slow the mortgage market, leading lenders to be both:

  • overly conservative in qualifying borrowers; and
  • overly eager to pass the price of the increased risk on to borrowers, leading to prohibitively high mortgage rates.

As a result, the proposed guarantee comes across more as a false concession to liberals, while still irking conservatives due to its big-government flavor.

A welcome delay

We bring you this analysis since secondary mortgage market reform has a tremendous impact on the nation’s housing markets. The creation of Fannie and Freddie forever changed the American housing landscape, and its dissolution (if that ever happens) will have just as dramatic an effect.

In spite of the popularity and above-the-fold headlines this bill has made, nothing has actually happened yet. As one Zillow analyst poignantly propounded,

“The current Congress has a record of enacting legislation only when confronting a hard deadline, which does not exist in this case, although investors in Freddie Mac and Fannie Mae will continue to push for some resolution as to the future ownership of the GSEs.”

This point is very well taken. It’s likely any substantive change to the current GSE structure will not occur at least until the next major elections in 2016.

The GSEs now solid profitability will only slow an already retarded reform process. And that’s okay. With the addition of QM and ability-to-repay quickly becoming the gold standard for mortgage lending, things are actually going quite smoothly.

Of course a robust private mortgage market is preferable to the current, federally subsidized system. But you must recall the reason Fannie and Freddie were socially engineered in the first place. Without them, the markets may self-correct, but not without an extreme slowdown in the proliferation of U.S. homeownership.

We already have the manifold factors of un- and underemployment as well as middle-income stagnation contributing to a declining U.S. and California homeownership rate. With the looming possibility of rising interest rates as a result of the Fed’s stimulus taper, any wind down ought to be done with extreme caution and sensitivity to this still tremulous market.