Housing Finance Reform: Fool Me Once Shame On You, Fool Me Twice Shame On Me
In 1992 Congress enacted a bill to regulate Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac. Called the "Federal Housing Enterprises Financial Safety and Soundness Act" (the Safety and Soundness Act), its ostensible goal was to protect taxpayers.
Yet by 2008, the GSEs required a taxpayer bailout and the affordable housing mandates the bill contained had harmed millions of homeowners.
Last month Senators Bob Corker (R-TN) and Mark Warner (D-VA) introduced the "Housing Finance Reform and Taxpayer Protection Act of 2013" (the Taxpayer Protection Act), which also promises to protect taxpayers, but, like the Safety and Soundness Act, poses a danger to homeowners and taxpayers alike.
Congress always promises that the latest guarantee proposal will be self-supporting and protect the people from losses. Yet taxpayers have repeatedly been fooled--the GSEs, the Federal Savings and Loan Insurance Corporation, the Federal Deposit Insurance Corporation, the Pension Benefit Guaranty Corporation, the National Flood Insurance program, Social Security, and Medicare being some of the more notable bailouts.
These programs inevitably fail because government guarantees suffer from three flaws: an inability and unwillingness to price for risk, the resulting asset allocation distortions, and the politicization of risk-taking. In the case of the proposed Federal Mortgage Insurance Corporation (FMIC), it will inevitably promote pro-cyclical policies that increase leverage during boom periods, creating the very risk the Taxpayer Protection Act purports to protect against.
The bill instead should be called the Government Mortgage Complex Act. It solidifies the federal government‘s grip on the mortgage market and combines crony capitalism for industry supporters and crony socialism for community advocates by providing billions in revenue for each. It would be a replay of the reckless "affordable housing" experiment begun by the government in the early 1990s. This experiment cost America's homeowners trillions of dollars as risky lending for political ends drove the homeownership rate and home prices to unsustainable levels.
The central lesson of the Safety and Soundness Act was that its imposition of wide-ranging affordable housing mandates on the GSEs trumped weak and ineffectual provisions purporting to protect the taxpayers. In a similar fashion, the Taxpayer Protection Act places conflicting "principal duties" on the FMIC. While there is a duty to "minimize any potential long-term negative cost on the taxpayer," this will inevitably take a back seat to its duties to "ensure, to the maximum extent possible a liquid and resilient housing finance market and the availability of mortgage credit." It is also given authority to ensure "access to mortgage credit in the secondary mortgage market" and must consider how its insurance operations "influence mortgage affordability." The housing lobby has a financial interest in making sure this second set of duties is vigorously and fully followed, while taxpayers will be left to fend for themselves.
These lobby groups argue that a government centric housing system is necessary to assure availability, accessibility, affordability, and liquidity. We learned from the last experiment that "availability" means subprime lending, "accessibility" means entitlements, "affordability" means subsidies, and "liquidity" means the availability of government guaranteed credit in good times and bad. For example, availability would require the widespread use of subprime loans with low down payments, low credit-score requirements and high debt-to-income ratios. The result would be a correlated national housing market backed by the taxpayer, substantially increasing the risk of a painful nationwide price correction. Such a system would undermine responsible, sustainable homeownership for all.
Fortunately, the Taxpayer Protection Act has competition. Last week the House Financial Services Committee voted to send the Protecting American Taxpayers and Homeowners Act of 2013 (PATH Act) to the full House. It provides for a largely free home finance market with a government guarantee limited to federal agencies like the FHA. The Path Act materially reduces the federal government‘s grip on the mortgage market and ends both crony capitalism and socialism.
The PATH Act puts the Government Mortgage Complex on notice that its days may be numbered.