It's been five years since Fannie Mae and Freddie Mac went under during the financial crisis. Since then, the mortgage giants have been in conservatorship. Congress is still pondering what to do. Everyone's pretty much agreed that the two should go. (For the record, neither lends money to homeowners directly; they buy mortgages and turn them into financial instruments that can be traded — thus pumping more money into the housing-finance market.) The question is, what should replace Fannie and Freddie? And it's there that the House conservatives admired by the tea party have offered an intriguing solution, albeit one that's galvanized many other Republicans and business interests in opposition.
The plan, proposed back in 2011 by Jeb Hensarling, the chairman of the House Financial Services Committee, would abolish Freddie and Fannie; but the big thing his proposal would do is eliminate any guarantee that the government would bail out a new entity. The bill would create a platform for investors to securitize mortgages — kind of like the old Fannie — but there'd be no fallback rescue plan. Hensarling says this would end "the boom, bust, and bailout cycle," because investors would take fewer chances with their money; that caution would remove the fuel that triggered the flood of housing finance that, in turn, encouraged people to gleefully buy what they couldn't afford — creating the price bubbles and defaults that led to the financial crisis. What's more, Hensarling's plan would rule out a huge price tag like the $180 billion to bail out Freddie and Fannie.
Over in the Senate, Mark Warner and Bob Corker see it differently. The Virginia Democrat and the Tennessee Republican are known for seeking common ground in a divided chamber. Together, they have been working for more than a year on their own plan for abolishing Fannie and Freddie and replacing the two entities with a mortgage market that requires large amounts of private capital to obtain a government guarantee. In other words, the industry would be putting up its own kind of insurance in case things go wrong, akin to the way plain-old banks pony up insurance money to protect customers' deposits. But if a catastrophic economic event occurs, the government then would provide a guarantee for investors. The president has praised the Corker-Warner approach, and his administration had provided considerable technical assistance. "We've been on the phone with them a lot," Corker says.
Both senators say the guarantee is essential to preserving the 30-year mortgage. Without a government backstop, they argue, investors will not finance a risky endeavor such as the standard mortgage loan — which may appear vanilla to homeowners but to investors represents considerable risk because interest rates fluctuate wildly over the generation-long term of the loan. "If you don't have this [guarantee]," Warner says, "there would be dramatically higher interest rates, no 30-year mortgage, and you would see a dramatically different housing market."
The myriad groups involved in housing overwhelmingly back the idea of keeping a guarantee. "We're actively and aggressively opposing [the House bill]," says Jamie Gregory of the National Association of Realtors. The housing phalanx in Washington is a formidable one, involving lobbies from financial institutions to builders to community activists who want more affordable housing. "Everybody in the industry believes that [Fannie and Freddie] reform needs to take place ... but the complete elimination of the government guarantee is not viable," says David Stevens, president and CEO of the Mortgage Bankers Association.
While those concerns are legitimate, eliminating the government backstop may be less risky than it seems. Here's the case for getting rid of the guarantee. The first reason is that it created a moral hazard, encouraging investors in mortgage-backed products to be reckless, because they knew they could be bailed out. That irresponsible spending on the housing side made it ridiculously easy to get a loan, thereby sending demand and prices up, creating the famed bubble. It's a stretch to say Fannie Mae alone caused the financial crisis; many other actors played a part. But there's no question that the guarantees are a big problem, and it's fair to ask if the more sensible guarantees in Corker-Warner would still encourage bubbles.
There's another reason for getting rid of the guarantee: evidence of enough money floating around the system to keep the 30-year mortgage alive and well, despite the housing lobby's fears. Look at the market for "jumbo" mortgages, those loans too large to have had a guarantee under Fannie. They have historically done well. Who's to say funding can't be found for less valuable 30-year mortgages? "From what I know about capitalism," Hensarling says, "if somebody demands a product, they'll get it." Those in the Housing Industrial Complex want the guarantee, despite its problems in the past, because they fear what would happen to interest rates and availability of capital. Fair enough. If the critics are right and the money does dry up for the housing market, Congress can always turn back to some kind of guarantee. But first, let's see if the market works.
Warner and Corker would like to get their bill moving to the Senate floor this year. "I am actually optimistic," Warner says. And, indeed, his bill has bipartisan cosponsors and is likely to become the basis for a Senate Banking Committee bill. For his part, Hensarling will have to sell the idea to a House Republican Conference that will be under pressure to block it unless he backs down on guarantees. That would be an unfortunate retreat. The guarantees didn't cause the financial crisis, but they made it worse. Industry and the markets cling to them. And that may be exactly the reason to be done with them.