Housing Finance Reform Proposals Seek Larger Role for Private Sector

WASHINGTON – Lawmakers and the Obama administration are increasingly optimistic an agreement can be reached that would reduce the government’s role in the mortgage finance market as proposals aimed to reform mortgage giants Fannie Mae and Freddie Mac continue to emerge.

In the aftermath of the financial crisis, the Federal Housing Finance Authority (FHFA) took control of Fannie and Freddie when they needed a $188 billion bailout. As a result, the government now guarantees the vast majority of mortgages in the U.S. Last year, the two provided support for approximately $1.3 trillion of the roughly $1.9 trillion in single-family home mortgages.

The two companies buy loans in the secondary market and package them into securities on which they guarantee payments of principal and interest, and then they sell the securities to investors.

Lawmakers fear this situation could put taxpayers on the hook in the event of a market crash. Republicans and Democrats agree that Fannie and Freddie have to go, but they disagree on the role the government should play in housing finance.

Sens. Mark Warner (D-Va.) and Bob Corker (R-Tenn.), both members of the Senate Banking panel, have drafted a bill that would wind down Fannie and Freddie within five years and establish a government-managed insurance fund, similar to the role the Federal Deposit Insurance Corporation plays in insuring bank deposits. This fund would collect insurance premiums and provide a backstop only after a certain amount of private capital dries out. The purpose of this is to incentivize companies securitizing mortgages to manage risk more carefully.

The Corker-Warner proposal creates a mutual organization to act as an entry-point for small lenders to the secondary market. In this secondary market, a bank makes a loan and sells it to a private investor who then securitizes it to other private investors.

The involvement of Fannie and Freddie in the mortgage market, and the government guarantee that goes with it, has helped maintain the availability of the American housing sector’s backbone: the 30-year fixed-rate mortgage.

This is why Maxine Waters, the top Democrat on the House Financial Services Committee, is putting forward a proposal that would maintain government involvement. Her plan also closes down the mortgage companies, but maintains government participation through a guarantee, paid for by the mortgage industry, to capitalize an insurance fund. Instead of Fannie and Freddie, her bill creates a new cooperative-owned mortgage security issuer, she said Tuesday in a speech at an event hosted by the Bipartisan Policy Center.

One of the criticisms of the Corker-Warner bill is that it requires private investors to take the first 10 percent loss of the credit risk on mortgage securities. The Waters bill would share the credit risk more flexibly by enabling the new regulator the ability to adjust the requirements when the private market constricts.

Another House bill, the PATH Act, introduced by Financial Services Committee Chairman Jeb Hensarling (R-Texas), would move more aggressively towards privatization of the mortgage market.

Hensarling’s plan would mostly privatize the housing finance market, leaving the Federal Housing Administration (FHA) and other government housing agencies to provide loans for low-income and first-time homebuyers.

The proposal would end Fannie and Freddie within five years and replace them with a National Mortgage Market Utility, a new nongovernmental, not-for-profit cooperative that would develop “best practices” for mortgage securitization. The new entity would not receive any federal government guarantees and would be barred from issuing securities.