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Johnson-Crapo's Reemergence Ruins Reg Relief Bill

Last year, an overhaul of Fannie Mae and Freddie Mac called Johnson-Crapo—named after then Senate Banking Committee Chairman Tim Johnson (D-S.D.) and Ranking Member Mike Crapo (R-Idaho)—went down in flames after observers found that the bill was not reform, but a massive expansion of the government’s role in housing.

One of the most vocal opponents of Johnson-Crapo was Sen. Richard Shelby (R-Ala.), who voted against the bill in the Senate Banking Committee and blasted it in his statement in committee and it media interviews. “Shelby Opposes Massive New Regulator and Taxpayer Exposure in Housing Regulation Bill,” exclaims the headline of a press release from Shelby’s office on the date of the Senate Committee vote on May 15, 2014.

Though the bill narrowly passed the committee, support for the bill died on the vine and it was never even brought to the Senate floor for a vote. The bill was torpedoed after vocal opposition from Shelby as well as that from 26 leaders of conservative and free-market groups who signed a letter blasting Johnson-Crapo that was coordinated by the Competitive Enterprise Institute. In addition to CEI, signatories included the Club for Growth, Americans for Tax Reform, Freedom Works, and the American Family Association.

Fast forward to one year later from that May. Republicans have taken control of the Senate, and Shelby is now chairman of the Senate Banking Committee. Shelby has just introduced the “Financial Regulatory Improvement Act of 2015,” scheduled to be market up Thursday, May 21. What’s in the bill?! None other than a section that essentially does much of what Johnson-Crapo would have done in expanding the government’s housing role and exposing the taxpayer to more risk!

Sections 701-706, added at the last minute by Sen. Bob Corker (R-Tenn.), is entitled “Taxpayer Protections and Market Access For Mortgage Finance.” But in reality, it increases taxpayer risk by inviting the biggest banks “share” their risks with the government. This is exactly why Shelby and the policy groups criticized about Johnson-Crapo.

Like Johnson-Crapo, these provisions would convert Fannie and Freddie, which currently buy mortgages issued by banks, into a type of backstop for mortgage-backed securities issued by financial powerhouses. The bill mandates creation of a “common securitization platform” under which banks would create mortgage-backed securities and engage in “risk sharing” with Fannie and Freddie, which would be responsible for the bulk of losses should the mortgages go bad.

But as in Johnson-Crapo, creating this government backstop is likely to make the moral hazard even greater and entrench “too big to fail” bailouts even further. As Joshua Rosner, co-author of the book Reckless Endangerment that documented Fannie and Freddie’s role in the financial crisis, wrote of Johnson-Crapo, “Unfortunately, the bill replaces Fannie and Freddie with an untold number of new government-sponsored enterprises by handing a massive taxpayer backstop to the nation’s largest banks.”

As with Johnson-Crapo , this bill attempts to shield itself from criticism by requiring that banks and other private investors take an unspecified “first loss.” But that still leaves any ongoing losses—however large they may be—to be absorbed by the GSEs, and ultimately the taxpayer. As Peter Wallison, senior research fellow of the American Enterprise Institute and commissioner of the congressionally created Financial Crisis Inquiry Commission, writes, "When the government backs any system—whether through deposit insurance, flood insurance, pension benefits or anything else—the beneficiaries have only limited interest in the risks they are taking.”

In his statement last year upon voting against Johnson-Crapo, Shelby said, “If Congress is to provide a backstop in housing, it should be clear, explicit and accounted for on-budget without gimmicks.” The same reasoning applies here, as this backstop is not on-budget and is full of gimmicks.

The provisions also perpetuate the Obama’s administration’s horrific “Third Amendment,” in which all of the GSEs’ profits are siphoned off to the U.S. Treasury Department in perpetuity—even after the GSEs paid back what they owed to taxpayers. The Third Amendment has also raised concerns that the profit sweep is leaving Fannie and Freddie with very little capital reserves, furthering the chance for more taxpayer bailouts should something go awry with the housing market again.

Yet while putting unnecessary restrictions on the Treasury Department selling its stakes in Fannie and Freddie—as the banks and auto companies were sold back to the private sector—the provisions do nothing about the Obama administration’s siphoning the GSEs’ profits and using them for any cause they see fit. At the very least, the bill should contain legislation from Rep. Marsha Blackburn (R-Tenn.) to require Fannie and Freddie to put aside some revenues in a “secondary reserved fund” that the Treasury Department can’t touch.

As I noted in my previous blog post, there are provisions in this bill that would provide modest but significant regulatory relief from some of the mandates of Dodd-Frank that are strangling community banks and credit unions. Hopefully, Corker’s provisions will be removed from the legislation, and Banking Committee members can vote on a clean bill consisting of regulatory relief and accountability measures for the Federal Reserve. But if the GSE provisions are not removed, the bill is a net negative and deserves to be defeated.