Since Fannie Mae and Freddie Mac were put into conservatorship in September 2008 there has been very little movement to fix them or reform the housing finance system. Treasury sponsored a conference in August 2010 on housing finance reform with ideas solicited from the public during the preceeding summer, but didn't offer formal ideas until a few weeks ago. Rep. Jeb Hensarling (R-TX) released a bill that dealt with Fannie and Freddie last spring, though that bill was DOA and didn't deal comprehensively with housing finance issues like FHA or covered bonds anyway. And the Dodd-Frank Act included a requirement that all regulators agree on a standard "qualified residential mortgage" definition so that a 5% risk-retention requirement could be slapped on everything that doesn't conform to that standard.
Given that the housing market is roughly $11 trillion, was the catalyst for the entire financial crisis, and continues to be the biggest problem facing the banking industry—and thus the broader economy—you'd think the GSEs would have been addressed a while ago. But few have wanted to touch them.
All of that has finally started to turn. The House GOP finding itself in the majority has started with calling hearings (I testified at the first of these that was solely focused on GSE reform). And the Treasury set of ideas (though late to the party) has provided at least some clarity on where the process has to go in order to see real reform.
The question is where will Congress, FHFA, and Treasury go from here? There a few possibilities (with options listed as letters to avoid confusion with the Treasury's three "options" for long-term housing finance reform):
Option A— House Republicans could propose a series of small bills that have largely bi-partisan support that would help protect taxpayers in the near-term and begin to encourage private capital back in to the system. With those passed over the next few months, Congress could then debate the harder, more central parts of housing finance reform with the goal of passing a good bill before the presidential election. This has been the approach of Rep. Scott Garrett (R-NJ), as outlined in his Feb. 9 subcommittee hearing asking for near-term steps on GSE reform.
Here are the kinds of relatively small legislative ideas that could be introduced in the near-term which would find both conservative and progressive support:
- End all affordable housing goals. This idea has deep support in the GOP and was endorsed by the Treasury white paper. Few think the goals are necessary even to continue the social policy goal of government supporting housing for the poor.
- Establish a legal framework for covered bonds. Rep. Garrett purposed a bill to do this last year and it is likely to be reintroduced again soon. There is little reason to opposed this idea, even if you don't think covered bonds will be welcomed by the market, having a framework for them—particularly outlining how to deal with defaults in an orderly way—can't hurt.
- Require the Treasury Department to approve new GSE debt issuance. This was a legal requirement up until the Clinton era when the practice was seen as too cumbersome for regulators and eventually it was stopped. But few could suggest requiring Treasury to once again follow the law on this practice would be a problem—it would bring transparency and accountability and wouldn't stop the GSEs from doing anything other than potentially problematic activities.
- Cap the portfolios of the GSEs, speed up the reduction, and restrict new activites to just MBS. Few argue the GSE portfolios are necessary and the conservatorship agreement already requires that they be wound down 10 percent a year. Speeding up the process would protect taxpayers and wouldn't impact GSE support of the secondary market. Requiring that the future purchases of the GSEs be limited to securitization activities should not cause progressives or conservatives much worry.
- Put all GSE employees on the federal payscale. There is little reason Fannie and Freddie can not operate on the GS compensation schedule if Ginnie Mae and FHA can do it. Few politicians will want to be seen defending high pay and bonuses for Fannie and Freddie.
- Put Fannie and Freddie on the federal budget. This would be a bit more controversial, but if tied to increasing the debt ceiling in May, could pass both houses of Congress. CBO and OMB have both been on record requesting this in the past, which would help this. And the Treasury white paper has all but pulled the trigger on the future survival of Fannie and Freddie.
- Stop all GSE charitable giving, lobbying activities, and taxpayer funded legal support of former staff and executives. Given that these institutions have been hemorrhaging money covered by taxpayers, these cuts to GSE spending should be welcomed on both sides of the isle.
- Increase g-fees. This has been suggested by many including myself, the Treasury white paper, and a recent JPMC bond trader hip-hop ditty.
- Wipe out common stock shareholders and shut down GSE public relations departments. This idea would be a bit more controversial, than the others but could pass if hitched to another of these relative no-brainers. This has been sought by a number of conservative commentors an would just support the Treasury position that we don't need the GSEs.
- Sell GSE patents and licenses to databases. This would not limit GSE activities but it would give the private sector an additional edge in the fight to displace Fannie and Freddie. This would only help homeowners in American and would in no way negatively impact federally subsidized housing other than to help more people not have to use it.
There has also been talk of expanding authority for the FHFA inspector general circulating in House Financial Services Subcommittee on Insurance, Housing, and Community Opportunity. All of these ideas could get combined into one "near-term support of encouraging private capital" bill, or be introduced separately. And they only represent the baseline of things that could be done. If I had my druthers I would also like to see a one-time cut in the conforming loan limit for the GSEs and FHA by 20% to take place immediately and a requirement that all loans purchased or guaranteed by the government be required to have a minimum of 10% down-payment by the end of this year. These steps would protect taxpayers and help the market in the near-term while long-term housing finance reform is discussed.
Option B— House Republicans could introduce a large, comprehensive bill that addresses all aspects of long-term GSE reform and FHA reform in a very free market way. Such a bill would basically just have the aim of getting passed in the House. But such an approach would help draw a line in the sand for where the GOP wants to take the debate on housing finance reform. Politically it would allow the GOP to claim they proposed a plan, but it would run the risk that little would be delivered to the President's desk on the topic before the 2012 election. This has generally been the approach favored by Rep. Hensarling, who has said repeatedly that he wants to reintroduce his comprehensive GSE reform bill at some point in the near future.
Option C— Do nothing and let Treasury and FHFA use their current authority to reform the system. Under this approach, Congress could simply get out of the way and let the executive branch try to fix the system. FHFA could on its own increase g-fees to run Fannie and Freddie out of the system. They could also increase underwriting standards in such a way that more business goes to private sector financiers than the GSEs. Furthermore, they could use powers already granted by Congress (though HERA) to put the GSEs into receivership and fully wind them down. Their charters would still technically exist under this approach, but would be virtually unimportant. HUD could also institute changes at FHA on its own to make their lending more narrow, direct, and governed by better underwriting standards.
From where I sit, and in conversations I've had with some of the players involved, the most likely outcome is some combination of all these options. There will likely be small bills dropped in the near future and then later a big bill. But not much will get through in the near-term, so Treasury will have to start the wind down process itself—as it suggested it would in its white paper. The one thing that can't happen without legislation is the creation of a long-term, explicit government guarantee program.