Senators Bob Corker (R., Tenn.) and Mark Warner (D., Va.) have introduced a bill that would make the two-headed monster that is Fannie Mae and Freddie Mac into a one-headed monster, on the theory that this will render it easier to decapitate. Inasmuch as the bill does not end the public guarantee of mortgage securities, it is an incomplete remedy, but it is one that is nonetheless worth pursuing.
Senator Corker, to his credit, introduced a bill in the last Congress that would have ended the public guarantee; to his colleagues’ discredit, it attracted very little support. Corker-Warner has been put forward as a second-best measure. It would replace Fannie Mae and Freddie Mac — two very problematic institutions with a joint history of managerial ineptitude and corruption — with a single new entity, the Federal Mortgage Insurance Corporation (FMIC). The FMIC would insure mortgage-backed securities with the proviso that issuers put up first-loss capital amounting to 10 percent of the amount insured — much more than they are required to do under current arrangements — in addition to paying insurance premiums and fees that would support the FMIC’s insurance fund and its capital cushion. Eight years into the FMIC’s career, it would consult with the Government Accountability Office and draw up a “living will” — a plan for its dissolution through the disposal of its assets — which it would submit to Congress. Congress at that time would have a choice between executing that living will, and thereby moving to a fully private system of mortgages with no public guarantee, or maintaining the FMIC as is.
Given that Congress has failed to make any serious move toward reforming Fannie and Freddie, and given that Senator Corker’s earlier efforts to simply end the public guarantee went nowhere, this plan may be the best of the politically plausible options at hand.
The problem is that with the mortgage market in partial recovery and the Fed keeping interest rates near historic lows, Fannie and Freddie are generating revenue, a fact that has not gone unnoted by the piggy little eyes of congressional appropriators and the Obama administration. That creates a double bind: It is impossible to reform Fannie and Freddie when the economy is down, because Washington fears turbulence in the housing market, but it is also impossible to reform them when the economy is good, because they throw off money.
Critics of the bill, notably Peter J. Wallison, have argued that Corker-Warner won’t work, that it will only create a system that “fosters the same loose lending that led to the housing debacle.” And Wallison puts his finger on the key weakness in the arrangement: If it charges appropriately for the risks it insures, FMIC will come under pressure from Congress, the administration, mortgage lenders, realtors, and housing activists to artificially reduce its rates and thereby maximize the availability of mortgages, and risk will once again be pushed onto taxpayers.
This is not a trivial concern. The federal government’s history of running insurance funds is not a particularly good one: The National Credit Union Share Insurance Fund required a bailout, the Federal Savings and Loan Insurance Corporation went bankrupt, and even the Federal Deposit Insurance Corporation has seen its fund go upside-down during financial crises. One reason for this, as Alex J. Pollock argues, is that government guarantees make financial catastrophes more likely by encouraging firms, investors, and borrowers to take on excessive debt.
Corker-Warner addresses that to some extent by increasing the losses imposed on lenders, and the bill might benefit from raising that 10 percent first-loss figure to an even higher number. A solid 20 percent down-payment requirement, quaint as that notion now seems, would go a long way toward establishing the quality of the underlying mortgages — though even the 10 percent requirement is already generating some squealing from the industry. Other measures, such as seeing to it that the new FMIC is not staffed with Fannie and Freddie holdovers, could also do a great deal to bolster the credibility of the new agency. And of course it would be best if all this only had to last for eight years, at which point Congress should vote to dissolve the FMIC. The critics are correct that Corker-Warner will not eliminate the problems associated with the public guarantee, but there is no measure under consideration that would, and prior attempts to do so have been rebuffed.
Properly understood as a transition to a fully private system of mortgage insurance, Corker-Warner represents a step in the right direction. But it is not and cannot be the last step.