Senators Tim Johnson (D–SD) and Mike Crapo (R–ID) recently released their new housing finance reform bill. As expected, the new bill makes the bad features of its Senate companion even worse.
>>> Check Out: Johnson–Crapo Housing Finance Reform Misguided
The core of both this bill and the one introduced by Senators Bob Corker (R–TN) and Mark Warner (D–VA) is the Federal Mortgage Insurance Corporation (FMIC), a new federal regulator that serves several purposes, such as monitoring the safety and soundness of various financial institutions. Most importantly, the FMIC would take over the insurance function that government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac provide on mortgage-backed securities (MBS).
Currently, Fannie and Freddie sell MBS and provide insurance for both principal and interest payments to investors. Because the government sponsors Fannie and Freddie, markets have always treated GSE securities as implicitly backed by the federal government.
The FMIC, on the other hand, would provide an explicit taxpayer guarantee of 90 percent of losses on these securities. Proponents of this new approach argue that it improves the old system because the FMIC requires private capital to share in any losses. Both Senate bills require a 10 percent first-loss provision, meaning that the FMIC picks up losses only after private investors lose their 10 percent.
This approach is not much of an improvement, because it allows private investors to price their own risk, knowing that their losses are capped. That is, investors know ahead of time they can lose only 10 percent, and they can pay less (up front) for securities to compensate for those restricted losses. Oddly, Johnson–Crapo makes this risk-sharing even less meaningful.
Section 305 of the bill allows the FMIC to waive the risk-sharing provision in the event of a financial crisis. In other words, 90 percent of private investors’ losses will be covered unless there’s a crisis, in which case all of the losses will be covered. The system envisioned in Johnson–Crapo leaves us with more moral hazard than the GSE system that crashed in 2008.
Advocates of this approach claim that it is not a taxpayer-funded bailout because the FMIC pays for losses out of a federal mortgage insurance fund (MIF), and investors pay fees to establish the MIF. The problem is that the MIF works much like other government insurance funds—it amounts to obligations that, in the event of a crisis, are simply paid from tax revenue. Section 303(d)(9) makes this feature explicit:
The full faith and credit of the United States is pledged to the payment of all amounts from the Mortgage Insurance Fund which may be required to be paid under any insurance provided under this title.
There are many other problems with both Senate bills, such as the expansion of housing trust funds and affordable-housing mandates, but the explicit backing of investors during a crisis is expanded in Johnson–Crapo. Between these Senate bills and the Dodd–Frank Act, the federal government is close to completely taking over the housing finance market. Taxpayers—and consumers—deserve much better.