Two years. Comprehensive housing finance reform in two years. That is what Secretary Timothy Geithner asked Congress to deliver yesterday in testimony before the House Financial Services Committee. It is an ambitious goal. And with persistent unemployment, a historically deep recession, and lethargic recovery all tied to woes in the housing market, getting reform in place so the private sector can once again move back into funding mortgages is desperately needed.
In fact, given that troubles in the $11 trillion housing market continue to be the biggest problem facing the banking industry -- and thus the broader economy -- you'd think Congress would have addressed Fannie Mae, Freddie Mac and FHA a while ago.
Luckily, with new leadership in the House and the administration’s housing finance report endorsing the elimination of the government-sponsored mortgage giants that are propping up the market today that they helped crack the foundation of yesterday, there is a chance that real reform could take root. But it will be a tricky minefield to cross to get there.
Having spent a considerable amount of time on Capitol Hill in the past few months, talking with congressional staffers, and testifying last month in a GSE reform hearing, we see three possible political roads ahead.
First, Congress could talk a lot, but ultimately do nothing and let the executive branch try to fix the system. Secretary Geithner testified this morning that the Treasury and the Federal Housing Finance Agency plan to increase the guarantee fees charged by Fannie and Freddie, as well as promote stricter underwriting standards. He also said that the Federal Housing Administration will raise its premiums later this year. Existing legislative authority would allow the Treasury to even put the GSEs into receivership and increase the speed of the portfolio wind-down process to eliminate Fannie and Freddie completely.
It is unlikely that the Treasury would pursue this route with the appropriate speed necessary, but through other regulatory processes, such as defining qualified residential mortgages and new rules sure to come from the Consumer Financial Protection Bureau, the executive branch could do a lot to impact housing without Congress at all.
Second, House Republicans could introduce a comprehensive bill that would provide a path to eliminate GSEs over five years, provide reform to FHA, and promote freer mortgage insurance and financing markets. This approach is favored by Texas Rep. Jeb Hensarling, who introduced a GSE reform bill last year and has said repeatedly that he plans to do so again. Such a bill would be unlikely to make it through the Senate, but if done properly would clearly articulate the GOP position on free market reform. Politically, it would allow Republicans to claim they have a plan, but it would also risk delaying any substantial reforms until after the 2012 election.
Third, House Republicans could introduce a series of small bills that would be likely to get bipartisan support. These bills, designed to get approval in the Senate as well, could be used as short-term solutions to protect taxpayers and encourage private capital back into the system. This approach would not necessarily exclude a large bill dropping at the same time. But with several small bills passed over the next few months, Congress could then take up a large piece of legislation and spend time debating the harder, more central parts of long-term housing finance reform, with the goal of passing a substantive bill before the presidential election. New Jersey Rep. Scott Garrett held a House subcommittee hearing to promote this approach last month.
Should Congress decide to go this route, there are a number of measures that should enjoy the support of both Republicans and Democrats.
The first step would be to end all affordable housing goals. Regardless of whether you think the government should be promoting home ownership, we must make a clear distinction between mortgage finance and affordable housing policy. The Treasury Department white paper agreed that these are unnecessary. And the collapse in the homeownership rate back to mid-1990s levels indicates promotion of affordable housing does mostly the opposite of its goals. Social policy that wants to spend money subsidizing low-income Americans could still be pursued, however, without these goals, just in a more direct way to not distort meaningful mortgage finance reforms.
Next, to promote more private financing, Congress should establish a framework for covered bonds. There is little reason to oppose legislation advancing this popular form of European mortgage financing. Even if you don't think the market will welcome covered bonds, it can't hurt to have a framework in place.
Fannie and Freddie should also be put on the government budget to make their books more transparent and steps should be taken to bring their finances under control. While this may be a somewhat controversial idea, there should be no debate about going back to the old system of requiring the Treasury Department to explicitly approve any new debt issued by the GSEs. Neither should there be much disagreement about putting Fannie and Freddie employees on the federal pay scale, to bring their payroll in line with other government agencies, particularly since Ginnie Mae is able to operate with federal compensation packages. It should also be easy to pass legislation that puts a halt to all GSE charitable donations, lobbying activities, and taxpayer-funded legal support for former employees.
Most importantly, steps should be taken to slowly reduce the size of the GSEs, in order to allow more private-sector involvement in the marketplace. The conservatorship agreement already requires their portfolios to be wound-down by 10% a year, which could easily be sped up by Congress without putting the housing recovery at risk. Limiting their new activities to the securitization market and increasing their guarantee fees could compliment this legislative initiative. Such moves would clearly define and limit the role of the GSEs, allowing more space for private competition but also keeping them very active for those politicians worried about moving too fast.
Finally, Congress could order common stockholders of Fannie and Freddie to be wiped out and the GSE public relations departments closed. This certainly would be more controversial than some of the other ideas, but it would support the Treasury position that the GSEs will eventually go away and the market should not expect them back. This would help shape investors' view of the future of the mortgage market. And to help investors get back in the game, Congress could sell some of the GSEs’ patents and license access to their troves of housing data.
These are all good first steps that should be supported by both progressives and conservatives. This later approach would certainly be preferable to the first two, since it would give Congress time to debate a comprehensive overhaul of the mortgage finance industry while allowing reform to take hold for a smooth transition when a final decision is made.
That is not to say the small-step approach will yield a good mortgage finance framework in the end. There is still argument over the importance and guilt of Fannie and Freddie. There is intense interparty and intraparty debate on a number of issues, including whether we need a federal guarantee. The chasm between the House and Senate where ideas good and bad go to die is sure to be an Apollyon on the road to reform. And the presidential campaign next year is unlikely to help encourage policymakers to put their necks on the line.
But if Congress were to move quickly on these small-step changes -- combined with the scheduled conforming loan limit drop and the Treasury’s commitment to increase underwriting standards, g-fees, and FHA insurance premiums -- then we should see private capital start creeping back into the system and be poised to rush back into mortgage finance once all the rules of the road are made clear. That just might be the encouragement Congress needs to push through the overhaul that has been needed for so many years.
This article was originally published by Minyanville.com on March 2, 2011.