US Mortgage Finance Reform and the Future of Fannie and Freddie

Fannie Mae and Freddie Mac were taken into US government conservatorship in 2008 with a US$188billion injection provided by the American taxpayers. Beginning in the early 1990s, policies loosened Fannie Mae’s and Freddie Mac’s credit standards enabling less qualified borrowers to obtain a mortgage. At the time, it appeared that an increase in home ownership – and the ‘American Dream’ – was beneficial to society. The ideal of greater home ownership quickly dissolved to a cruel reality as many unqualified homeowners defaulted on their mortgages; causing Fannie Mae and Freddie Mac to absorb immense losses and ultimately forcing them to rely on a taxpayer bailout to ensure the mortgage market’s liquidity.

The Legislative Frameworks

The Corker-Warner bill, formally known as The Housing Reform and Taxpayer Protection Act, was introduced in late June 2013. The bill was spearheaded by US senators, Bob Corker, a Tennessee Republican and Mark Warner, a Democrat in Virginia.

The bill is vast, but one pillar of the proposed legislation is the creation of the Federal Mortgage Insurance Corporation (FMIC) as an independent federal agency similar to the Federal Deposit Insurance Corporation (FDIC) for banking institutions. The FMIC will provide liquidity through a form of guarantee to the secondary mortgage market. The bill aims to dissolve Fannie Mae and Freddie Mac over the course of five years and replace their function with privately capitalised entities. The FMIC’s function is to act as a guarantor to these private entities and step in only once a sufficient amount of losses have been absorbed by the private entity; the proposed loss threshold is 10%.

Last month, Senate Banking Committee chairman, Tim Johnson (Democrat, South Dakota) and Member, Mike Crapo (Republican, Idaho), released their version of mortgage finance reform, entitled The Housing Finance Reform and Taxpayer Protection Act of 2014; also known as the Johnson-Crapo bill.

The Johnson-Crapo bill is an extension of the Corker-Warner bill’s framework. Both envisage the FMIC being in place as the guarantor of last resort and private entity losses would have to be endured before the FMIC guarantee came into play. The Corker-Warner bill eliminates many of the affordable housing programmes currently in place, while the Johnson-Crapo bill attempts to make market incentives to ensure underserved, but qualified borrowers have the accessibility to a mortgage loan. The element of serving the underserved segments of the mortgage market is the most differentiating point between the two proposed bills, along with the minimum down-payment requirement for first-time homebuyers of 3.5% for Johnson-Crapo compared to the 5% requirement for Corker-Warner.

Both bills enjoy bipartisan support; however, many right-wing conservatives argue that the government’s role in the mortgage market is still too large. Some proponents of each bill feel that although Fannie Mae and Freddie Mac will technically be dissolved, a new government behemoth will take their place in the form of the FMIC. In the case of massive homeowner defaults rates – like those witnessed in the most recent financial crisis – the government would again be tasked with ensuring a proper functioning mortgage market is underpinned through their guarantee of the mortgages.

Similar to both Corker-Warner and Johnson-Crapo, the Protecting American Taxpayers and Homeowners (PATH) Act was introduced by the House Financial Services Committee (FSC) chairman, Jeb Hensarling (Republican, Texas). The PATH Act was passed by the FSC, but has yet to get the nod from the entire House of Representatives. The act would create a public entity that would facilitate the pooling and securitisation of mortgages though a consistent platform, but there would be no government intervention; more specifically, no government guarantee of mortgage-backed securities in the secondary market.

The private market would be given discretion to create credit enhancements, should the market demand it. Like Corker-Warner, the PATH Act would wind-down Fannie Mae and Freddie Mac over the course of several years. If the act was to pass as-is, ultimately the entire mortgage market, both primary and secondary, would virtually be privatised throughout.

Conclusion

It is highly doubtful that any one piece of legislation will be enacted as proposed; however, the notion of mortgage finance reform is quickly becoming a reality and the impact will certainly be far reaching for both primary and secondary mortgage market participants.

The one constant provided by each piece of proposed legislation is the end of Fannie Mae and Freddie Mac. You can bet that every politician will want their name on one of the most revolutionary pieces of financial reform legislation in US history. Regardless of the political climate, and regardless of the mortgage market’s true contribution to the financial crisis, policymakers are going to ensure that Fannie Mae and Freddie Mac will not be in existence two years from now.

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