Freddie Mac headquarters by Shutterstock.com
- With a Federal Mortgage Insurance Corp, investors in mortgage-backed securities won’t worry about mortgage quality
- Corker-Warner housing reform bill is bad for homeowners, good for the Government Mortgage Complex
- Senate housing reform bill won't work, will lead to another meltdown
The Corker-Warner bill, introduced last week in the Senate, has received a lot of favorable media attention because it's bipartisan. Tennessee Republican Bob Corker and Virginia Democrat Mark Warner are the chief sponsors. Their intent is to eliminate Fannie Mae and Freddie Mac, the two government-sponsored mortgage giants that cratered in 2008 and were bailed out by taxpayers to the tune of $180 billion.
It would be easy to love a bill that gets rid of these two institutions—unless it fosters the same loose lending that led to the housing debacle. By keeping the government in charge, this bill does just that.
The recent financial crisis was the result of government housing policies. Beginning in 1992, these policies required Fannie and Freddie to lower their underwriting standards so people who otherwise lacked the credit standing or financial resources could purchase homes.
These policies set the two enterprises on the course one would expect when the government is your backer—use the taxpayers' credit card and provide what Congress's constituents want. In housing, those constituents are the Government Mortgage Complex: realtors, home builders and community activists.
Fannie and Freddie could take on the risks of these loans only because of the implicit backing of the federal government. But it was a good deal for Congress and two administrations, which could tout their support of wider home ownership. Buy now and pay later was the idea. Later turned out to be 2008, when the bill arrived in the form of unprecedented mortgage defaults that drove down housing prices by 30%-40%.
Now comes Corker-Warner. It will set up a new government agency, the Federal Mortgage Insurance Corporation (FMIC), to insure mortgage-backed securities and wind down Fannie and Freddie as the FMIC becomes operational. As with Fannie and Freddie, investors in mortgage-backed securities will not have to worry about the quality of the underlying mortgages.
A major feature of Corker-Warner is the requirement that the private sector share the insurance risk with the new FMIC. The bill specifies that a private risk-sharer like a bond insurer must take the first losses, no less than 10% on any securitized pool of mortgages. This is intended to protect the FMIC against losses, though it works only if the quality of the mortgages remains high.
But as with Fannie and Freddie, the quality of the mortgages will be the weak link. Realtors, home builders and community activists all want as many home buyers as possible. They are not concerned with fuddy-duddy obstacles like down payments, solid credit scores or low debt-to-income ratios. These interest groups and Congress will press the FMIC to lower its underwriting standards so that more and more loans can be insured.
The private bond insurer or other risk-sharer will understand the downside potential of low-quality loans and will charge for the additional risk. That cost will be incorporated into the mortgage, increasing the monthly payment and making the cost of mortgages too high for many potential borrowers.
The result? Congress or the administration or both will pressure the FMIC to lower its insurance fees so that the maximum number of people will be able to buy homes. Recall that the Federal Housing Administration required 20% down payments when it was born in 1934. It now requires a 3% down payment—and a government bailout.
The scheme envisioned in Corker-Warner will work for a while, as long as housing prices keep climbing, and with more and more people entering the homeownership sweepstakes, they will. As housing prices get higher, houses will look like good investments, which will bring in more investors and drive prices still higher. Eventually, it will all come apart, as it did in 2008.
Then who gets hurt? The investors in mortgage-backed securities are fully covered, so they come out whole. If we assume that investors and mortgage insurers in front of the FMIC were adequately compensated for their risk, they will have profited. Taxpayers could be hurt if the FMIC has not put away enough of its revenues to cover its own losses. And the FMIC won't have done so if, like the FHA, it lowered its rates to satisfy demands from Congress or the administration for riskier mortgages at lower cost.
The only certain losers will be homeowners. Many of them will lose their homes when the collapse in housing prices triggers a recession and they lose their jobs. Others will hang on to their homes even though their mortgages are underwater—but they won't be able to refinance or sell so they can go to where the jobs are. Almost everyone will live in a neighborhood blighted by empty foreclosed homes. Sound familiar?
Mr. Wallison is a senior fellow at the American Enterprise Institute.