One year ago today, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act. Despite the “Wall Street” moniker, the tentacles of Dodd-Frank’s 2,315 pages and hundreds of pending rules reach across many American streets to many types of businesses, from manufacturers that use derivatives to hedge inflation and interest rates, to small stores that extend credit through layaway plans.
Ironically, about the only two firms Dodd-Frank doesn’t touch are the two most responsible for the crisis: the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. In their new book, Reckless Endangerment, New York Times financial columnist Gretchen Morgenson and market analyst Joshua Rosner write that Fannie “led both the private and public sectors down a path that led directly to the financial crisis of 2008.” At the end of the book, the authors note with dismay, as have many conservative critics, that the law doesn’t lay a glove on Fannie and Freddie.
GSE reform is coming, promises the Obama administration. In an op-ed yesterday in the Wall Street Journal, which largely consisted of blasting Republicans for efforts to lessen Dodd-Frank’s impact, Treasury Secretary Timothy Geithner proclaimed, “We have started the process of winding down Fannie Mae and Freddie Mac and reforming the overall mortgage market.”
Yet Fannie and Freddie are bigger than ever, securitizing nine out of ten home mortgages and receiving unlimited guarantees from the taxpayer, thanks to the Obama administration’s Christmas Eve bailout of 2009. And one provision of Dodd-Frank has not only slowed the momentum of reforming the GSEs, but threatens to make them even bigger.
Dodd-Frank’s rules on “qualified residential mortgages” — as currently proposed in a joint regulation by banking agencies, the Department of Housing and Urban Development, and the Securities and Exchange Commission — aggrandize the GSEs by putting shackles on their private-sector competitors. The regulation sets overly strict rules for down payments for mortgages to be securitized, but then exempts from these requirements any home loan insured by the Federal Housing Administration or purchased by Fannie or Freddie.
The rules from Dodd-Frank’s section 941 are a multi-step process. They start with a requirement that firms originating mortgage loans retain 5 percent of the risk on their books. Because this requirement would price out many small financial institutions — the American Enterprise Institute’s Peter Wallison has written that such risk “can only be carried by a securitizer that has a substantial balance sheet” — the law creates various exemptions.
The regulators created one exemption for mortgages with down payments of 20 percent or more. Mortgages with very low down payments — and sometimes no down payments — were indeed part of the problem. They were also, as Morgenson and Rosner document, greatly encouraged by Fannie, Freddie, and the mandates of the Community Reinvestment Act. These loans were also encouraged by the Federal Housing Administration’s lowering of standards in the Clinton and Bush administrations for the mortgages it would insure.
But 20 percent is by many measures — to use a phrase popularized by a marginal political candidate — too damn high; it would rule out many mortgages and refinancings to responsible borrowers. And such a high threshold would be especially hard on families in states where the housing market has tanked and equity has eroded, if they need to move or refinance. A white paper for the Coalition for Sensible Housing Policy — an umbrella group of trade-association and policy groups, including the liberal Center for Responsible Lending — states: “For those borrowers that have already put significant ‘skin in the game’ through down payments and years of timely mortgage payments, only to see their equity eroded by the housing collapse, the proposed definition tells them they are not ‘gold standard’ borrowers and will have to pay more.”
Not to worry, say the Obama administration and Dodd-Frank’s architects. If a loan is bought by Fannie or Freddie or insured by the FHA, none of this applies. Loan originators do not have to retain 5 percent credit risk, and borrowers do not have to meet the high down-payment requirement. Borrowers would only have to comply with these agencies’ minimal guidelines — and these guidelines may be lowered even further. The Wall Street Journal reported earlier this month that the administration is considering “having taxpayer-owned mortgage giants Fannie Mae and Freddie Mac relax their rules for loans to investors.”
The administration also closed the door on the option of creating any exemption for private mortgage insurers if they create models to reduce risk, as some have proposed. In the Obama administration’s view, the answer is government backing for mortgages, period.
The good news is that a strong bipartisan bloc of more than 320 members of Congress isn’t buying the administration’s line. The legislators have written to regulators demanding the new rules be scrapped. The bad news is that if Congress doesn’t move fast to repeal, delay, or modify the qualified-residential-mortgage provisions, the administration is likely to dig in its heels, and the GSE-expansion option will become more appealing, even to some Republicans. Witness the bill of Rep. John Campbell (R., Calif.), which would create a single GSE potentially more costly than Fannie and Freddie.
Anticipation of the rule is already adding to the precarious state of the housing market, and is helping to fulfill the contrived prophecy that the GSEs are needed because the private sector won’t provide mortgages on its own. Private-sector firms certainly won’t if they are handcuffed while their GSE competitors roam free. On this anniversary of “financial reform,” it is clearer than ever that the road to reforming Fannie and Freddie starts with the repeal of provisions from Dodd-Frank.