The browser or device you are using is out of date. It has known security flaws and a limited feature set. You will not see all the features of some websites. Please update your browser. A list of the most popular browsers can be found below.
In his State of the Union Address on Jan. 28, President Barack Obama briefly referred to his hopes for reforming Fannie Mae and Freddie Mac, the two government-sponsored and publicly traded entities that support the mortgage market by buying and securitizing mortgages. Both companies failed during the 2008 financial crisis and had to be taken over by the government.
By “reforming,” the president unfortunately doesn’t mean “improving.” Rather, he likely means “privatizing.” In fact the most likely form of privatization at this point would feature the sort mix of private incentives and government guarantees that makes another financial disaster virtually certain.
The smart money in Washington is betting on the Housing Finance Reform and Taxpayer Protection Act, sponsored by Sens. Bob Corker, R-Tenn., and Mark Warner, D-Va. The Corker-Warner bill, put together by two of the more centrist senators in both parties, does not simply get the government out of the mortgage guarantee business — an idea that actually has a plausible argument in its favor.
Instead, Corker-Warner would replace Fannie and Freddie with a new a system in which private financial institutions could issue mortgage-backed securities (MBSs) that carry a government guarantee. In the event that a large number of mortgages in the MBS market went bad, the investors would be on the hook for losses up to 10 percent of their value, after which the government would cover the rest.
If you think that sounds like a reasonable system, then you must have already forgotten the housing crash and ensuing financial crisis. At the peak of the crisis in 2008 and 2009, the worst subprime MBSs were selling at 30 to 40 cents on the dollar. This means the government would have been picking up a large tab under the Corker-Warner system, even if investors had been forced to eat a loss equal to 10 percent of the MBS price.
The precrisis financial structure gave banks an enormous incentive to package low-quality and even fraudulent mortgages into MBSs. The system laid out in the Corker-Warner bill would make these perverse incentives even larger. The biggest difference is that now the banks can tell investors that their MBSs come with a government guarantee, so they stand to lose at most 10 percent of the purchase price. If the banks had little difficulty selling junk-filled MBSs that carried no government guarantee at all, just imagine a Corker-Warner future with government subsidies.
Certainly the Justice Department’s treatment of the bankers who packaged fraudulent mortgages and misrepresented their quality to buyers will not discourage the same behavior in the future. None of these people went to jail, and in most cases they are much richer today than they would have been if they had pursued an honest career.
The changes in financial regulation are also unlikely to provide much protection. In the immediate wake of the crisis, critics demanded that securitizers keep a substantial stake in the mortgages that they put into their pools to ensure that they had an incentive to securitize only good mortgages. Some reformers were demanding as much as a 20 percent stake in every mortgage.
Over the course of the debate that led to the Dodd-Frank financial-reform bill and subsequent rules formulated after its passage, this stake got ever smaller: Securitizers had to keep only 5 percent. And for mortgages meeting certain standards, they wouldn’t have to keep any stake at all.
In the view of some of those drafting proposals, only mortgages in which the homeowner had made a down payment of 20 percent or more passed this good-mortgage standard. That cutoff got lowered to 10 percent and then was dropped further, to 5 percent. Even though mortgages with just 5 percent down are four times as likely to default as mortgages with 20 percent or more down, securitizers will not be required to keep any stake in them when they put them into an MBS.
Anyone trusting that the bond-rating agencies would protect against the proliferation of junk MBSs missed what happened to the amendment proposed by Sen. Al Franken, D-Minn., in the rules-writing process of Dodd-Frank. The amendment, which passed the Senate with a huge bipartisan majority, would have eliminated the conflict of interest that results from having the banks issuing MBSs pay the agencies that assign ratings. The amendment proposed that the Securities and Exchange Commission (SEC) pick the rating agencies. This simple step would have taken away the incentive to rate every piece of junk as investment grade, as happened during the years of the real estate bubble leading to the financial crisis.
This change would have taken effect, except the SEC, after being inundated with industry comments, deciding that picking rating agencies was too complicated. As a result, we have the exact same system in place as we did during the bubble.
In short, the Corker-Warner plan to privatize Fannie and Freddie is essentially a proposal to reinstitute the structure of incentives that gave us the housing bubble and the financial crisis, this time with the added fuel of an explicit government guarantee on subprime MBSs. If that sounds like a stupid idea, you obviously haven’t spent enough time being convinced by lobbyists at one of Washington’s finest restaurants.
The views expressed in this article are the author's own and do not necessarily reflect Al Jazeera America's editorial policy.
Sen. John McCain, R-Ariz., said that the Crimea region of Ukraine might already be lost to Russian control