Why housing reform could make your mortgage more expensive

The Washington PostApril 29, 2014 

— More than five years after the government seized control of Fannie Mae and Freddie Mac, a Senate panel plans to take a major step Tuesday toward ending the mortgage giants’ state of limbo.

The Senate banking committee will consider a measure that would wind down the companies over a five-year period and shift most of the risk of mortgage lending to the private sector, an effort often cast as the last major piece of reform left to tackle after the 2008 financial crisis.

It may be days before the committee votes on the bill, which is expected to pass barring any last-minute surprises. Most of the panel’s 22 members – six Democrats and six Republicans – have signed onto it. Committee Chairman Tim Johnson of South Dakota and Sen. Mike Crapo of Idaho, the panel’s most senior Republican, are the legislation’s lead sponsors.

The suspense surrounds the final vote count. The more committee members that support the bill, the more likely that Senate Majority Leader Harry Reid will bring it to the floor for a full vote. Supporters of the measure are eager for quick action to build on the bipartisan consensus while Democrats remain in control of the Senate and President Obama remains in the White House. The administration supports the Johnson-Crapo measure.

“This might be the only real chance we have this decade to achieve reform,” Secretary of Housing and Urban Development Shaun Donovan said at a recent event hosted by the Bipartisan Policy Center.

But there are plenty of challenges ahead. While a wide range of coalitions support the idea of revamping the housing finance system, they don’t all agree on the means. Here are three potential stumbling blocks and the reasons why the average person should care:

The 30-year, fixed-rate mortgage: The staunchest Republican opposition comes from lawmakers who want to dramatically limit or end the government’s backing of mortgages in order to avoid a repeat of the $188 billion taxpayer-funded bailout of Fannie and Freddie in 2008.

But the Johnson-Crapo measure is built around the premise that the government’s backing is critical to preserving the 30-year, fixed rate mortgage – a mainstay of homeownership in the United States.

While Fannie and Freddie were like other publicly traded companies prior to the crisis, the market assumed that the government would step in if there were extraordinary losses, and it did. The legislation takes that implicit government guarantee, and makes it explicit.

Why? Because it’s the rare institution that wants to invest in mortgages for a 30-year stretch without some assurance that the government would step in to cover catastrophic losses, said Mark Zandi, chief economist at Moody’s Analytics. In most of the rest of the world, where governments do not back mortgages, the 30-year, fixed rate loan is tough to find.

But the Johnson-Crapo bill seeks to limit taxpayer exposure by having private capital absorb the first 10 percent of losses on mortgage-backed securities. That money would have to be exhausted before the government would cover additional losses.

If this 10 percent first-loss arrangement were in place when the housing market crashed, taxpayers would not have been nicked at all, the bill’s supporters say. Fannie, Freddie and private mortgage insurers lost less than half that much during the crisis, Zandi said.

The costs for borrowers: It’s widely accepted that mortgage rates will rise for borrowers under the Johnson-Crapo measure, but it’s unclear how big that rise would be.

Fannie and Freddie buy mortgages from lenders, package them into securities and sell them to investors. For a fee, they insure mortgages and pay investors should the loans go bad.

Under the new system, private firms or “guarantors” would take on the insurance role. They’re the ones that must set aside 10 percent capital and take a hit before taxpayers. In other words, they must be able to remain solvent if 10 percent of the mortgages they insure default.

But the legislation is vague on what kind of capital would count toward the 10 percent requirement, and each type of capital has a different cost. Whatever the costs, they would be passed along to borrowers in the form of higher interest rates.

Freddie analyzed a range of possibilities and concluded that the most aggressive interpretation of capital requirements could push mortgage rates 2.19 percent higher. That would increase the monthly payment for today’s average borrower by just over $300.

Freddie also included a more moderate interpretation, one that’s more in line with an assessment by Moody’s Analytics. One Moody’s analysis concluded that the measure would add less than a half percentage point to the average mortgage rate, or about $75 a month in extra interest payments.

Jim Parrott, a former housing adviser in the Obama White House, said there’s a need for the final legislation to narrow the range of possible interpretations. As it stands, the bill gives the federal regulator that oversees the guarantors wide discretion to calculate the 10 percent.

“The banking committee can remove the risk of a significant increase in pricing by simply narrowing the regulator’s discretion,” Parrott said. “If they do that, the impact on the cost of mortgages will be very manageable, certainly worth the benefit of a more sound mortgage system.”

David H. Stevens, chief executive of the Mortgage Bankers Association, said the Johnson-Crapo measure gives guarantors a decade to raise their capital to the appropriate levels. The impact won’t be felt immediately, but spread over time, likely a few basis points a year.

The affordable housing goals, or lack thereof: Fannie and Freddie are required to purchase a certain percentage of mortgages made for single-family homes and multi-family properties in under-served areas. The goal is to encourage lending to low- and moderate-income borrowers.

The Johnson-Crapo measure would get rid of the affordable housing mandates. Instead, it would use industry fees to provide funding for various programs designed to meet affordable housing needs, including one that promotes mortgages for underserved areas.

The fees would apply on all the mortgage-backed securities insured under the new system. Among the guarantors that insure the mortgages, the best performers would pay less in fees, an arrangement that’s designed to entice firms to reach out to the underserved.

But a number of housing and civil rights groups have expressed opposition, arguing that the incentives do not do enough to promote affordable home ownership, and close the wealth gap between working class Americans and everyone else, the groups said.

“For this central reason, the National Urban League intends to mobilize its membership and partners in opposition to this bill – or any subsequent housing finance reform legislation – that does not include affordable housing goals,” Marc Morial, the league’s chief executive, wrote in a recent letter to Johnson and Crapo.

The government’s most recent mortgage data shows that African Americans received only about 2.3 percent of the 1.3 million conventional mortgages originated in 2012, while Latinos received about 5.3 percent, Morial wrote.

The affordable housing goals have been a political hot potato for years, with conservative lawmakers singling them out a key reason behind the housing market’s collapse. Civil rights groups and housing advocates point to various academic and federal research that refutes that claim.

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