It is widely believed, for good reason, that little legislation will come out of this Congress. As we speak, there are questionable odds as to whether lawmakers can agree to keep the lights on for more than a few weeks at a time.
Still, there’s a chance that they could compromise on an important issue that’s recently surfaced: reforming the government’s role in housing finance. More specifically, members on both sides of the aisle are thinking about how to end the conservatorships of the Federal National Mortgage Association and the Federal Home Loan Mortgage Corp. and replace them with a different structure that could achieve bipartisan goals.
Putting aside the White House for a moment (there’s a pleasant thought), both parties occupy some common ground here. Both want to reduce taxpayer exposure to the structural risks that were built into the old system. Key players on both sides want to maintain some version, albeit reduced, of the government role in the plumbing of housing finance — to support, for example, the popular long-term fixed-rate mortgage, something that wouldn’t exist without Fannie Mae and Freddie Mac (and is scarcely seen in other countries). They also want to change the way that government support is provided today, through Fannie and Freddie, given their role in exacerbating the financial crisis.
To understand the stakes of this debate, we need to ask why these two institutions exist. In a process that adds a lot more liquidity to the housing finance system, they buy home loans (mortgages) from banks, bundle them and sell those bundled securities to investors. Instead of sitting on home loans, banks unload them to the “agencies” (Fan/Fred) and use the proceeds to make more loans.
There’s another key ingredient, one that’s essential to watch going forward. Those investors who buy the bundled securities from Fan and Fred also get a guarantee that they will be paid even if the underlying loans default.
Here’s how the agencies’ regulator explains it: “By packaging mortgages … and guaranteeing the timely payment of principal and interest … Fannie Mae and Freddie Mac attract to the secondary mortgage market investors who might not otherwise invest in mortgages, thereby expanding the pool of funds available for housing. That makes the secondary mortgage market more liquid and helps lower the interest rates paid by homeowners and other mortgage borrowers.”
Suppose there were no such agencies. Aren’t U.S. financial markets liquid enough that the flow of loanable funds to potential homeowners would be plenty robust without the government getting into the act?
Not according to Mark Zandi and Jim Parrott, two analysts with serious cred in this space. They argue that it’s a myth to believe that “making long-term, fixed-rate … mortgages broadly available on terms most Americans can afford” would occur without government support. Absent the agencies, “investors in these loans would demand a return so high it would make long-term, fixed-rate mortgage loans too expensive for most American households.”
The key political phrase there is “most households.” Democrats, including the new chair of the House Financial Services Committee, Rep. Maxine Waters (D-Calif.) — a powerful player in whatever happens next — want to be sure home loans are affordable for low-income families. Homeownership is the key source of wealth, for example, for low- and middle-income black families, and it stands near a 30-year low among African Americans. To be clear, ongoing housing segregation by race and the egregious lack of enforcement against it is a key factor in this outcome, but low-income housing advocates are clear that without the government backstop, home loans would be a lot costlier to those with lower incomes.
On the Republican side, Sen. Mike Crapo (R-Idaho), chair of the Senate Banking Committee, recently released the outline of a plan that, according the Wall Street Journal, “appears to incorporate many policy goals championed by top Democrats, such as House Financial Services Committee Chairwoman Maxine Waters of California.” His plan emphasizes “preserving the popular 30-year, fixed-rate mortgage” and promoting “access to affordable housing.”
At this point, many readers are probably thinking, with reason: “This all sounds like a great way to reflate a housing bubble, help a lot of people buy homes they ultimately can’t afford, and set the stage for another bailout.” In fact, the reason Fan and Fred, formerly private companies, are still mostly government-owned — more than 10 years after the financial crisis — is because they were bailed out, to the tune of $190 billion.
The key needle to thread here is thus achieving the housing finance goals both sides appear to seek. This means ending the agencies’ role as the dominant players in the secondary insurance market, as such dominance defines “too big to fail.” It’s also where the White House could jam the bipartisan effort.
Some in the administration want to overhaul the system in a way that removes its structural flaw — the toxic combination of its dominance and its artificially underpriced risk — but retain the government’s support. Others want to simply re-privatize Fannie and Freddie, with little to no government support. That’s a path that would embed the system’s flaws while sacrificing its benefits.
It’s also a path that’s probably unacceptable to Crapo and Waters, who are actively looking for ways to reduce the agencies’ dominance while maintaining their benefits. True, that solution is more complex, involving some type of “securitization platform” wherein a more heavily regulated Fan and Fred become but two players among many who buy and sell bundled mortgages. But an important fact is that this is basically how things have been evolving anyway, so at least on paper, it’s not a big reach to get from where we are to a better place.
My guess is that President Trump’s populist impulses would militate against taking steps that would whack the 30-year fixed-rate mortgage and raise the cost of housing finance. But those impulses are as chaotic as they are unpredictable, so stay tuned. It’s going to be a bumpy ride, but it could be one that ends with a sighting of that almost-extinct Washington creature: a legislative solution.