Senate to Consider Bipartisan Housing Finance Reform Bill

Apr 29, 2014 | Other Spending

The push among lawmakers to reform housing finance has picked up lately, as proposals have been emerging in recent weeks. The most prominent one in the Senate has been proposed by Banking Committee Chairman Tim Johnson (D-SD) and Ranking Member Mike Crapo (R-ID). Their legislation would reform the mortgage market by winding down Fannie Mae and Freddie Mac, the Government Sponsored Enterprises (GSEs) which guarantee over half of US mortgages, and replacing them with private entities and a federal government guarantee as a backstop. Given the budgetary costs associated with the federal government takeover of Fannie Mae and Freddie Mac and the importance of the mortgage market to the broader economy, GSE reform legislation is of considerable interest to budget watchers.


During the housing market collapse that began in 2007 Fannie Mae and Freddie Mac incurred substantial losses which resulted in both entities being placed in conservatorship by the Federal Housing Finance Agency (FHFA) in September of 2008. The federal government has provided $187 billion in assistance to Fannie Mae and Freddie Mac through the purchase of senior preferred stock. The amount of mortgages guaranteed by Fannie Mae, Freddie Mac and other government entities since the housing market collapse has increased substantially since they were placed into conservatorship.

The Johnson-Crapo legislation builds upon bipartisan legislation introduced by Senators Mark Warner (D-VA) and Bob Corker (R-TN). In the House, the Financial Services Committee reported legislation, the Protecting American Taxpayers and Homeowners Act, last year, although the legislation has not been considered by the House yet. Representatives John Delaney, John Carney, and Jim Himes have introduced legislation they describe as striking a middle ground between the Johnson-Crapo bill and the PATH Act reported by the Financial Services Committee.

How Johnson-Crapo Would Reform the GSEs

The Johnson-Crapo bill would gradually phase out Fannie Mae and Freddie Mac and provide for repeal of their charters within five years. Their role in guaranteeing mortgages would be filled by private sector guarantors regulated and backed by a new Federal Mortgage Insurance Corporation (FMIC). In contrast to the PATH Act in the House, the Johnson-Crapo bill would provide a federal guarantee for mortgage backed securities. However, unlike the implicit guarantee of GSEs prior to the government takeover, the guarantee would be explicit with costs fully accounted for and would be triggered only after private capital in the “first loss” position has been fully exhausted.

The Johnson-Crapo legislation would establish several tiers of protections intended to limit taxpayer liabilities. First, it would make several changes in requirements for mortgages to reduce the riskiness of mortgages that are issued, including codifying the credit and downpayment standards for mortgages currently being applied by Fannie Mae and Freddie, strengthening mortgage standard rules, and providing for greater oversight of mortgages among other reforms. Loans that do not meet these criteria would not be eligible for a government guarantee. Second, the legislation requires that private sector guarantors have sufficient capital to withstand losses equal to 10 percent of the securities they guarantee, twice as high as what Moody's Mark Zandi estimates would have been necessary for Fannie and Freddie to survive the 2007-2008 housing collapse. The private guarantor would be in the first loss position, and a Mortgage Insurance Fund (MIF), which would be financed by fees on mortgage backed securities, would cover losses only after the private guarantor has been wiped out. Taxpayer funds would only be at risk after both the private guarantor and the MIF were wiped out.

Budgetary Effects of GSE Reform

Legislation winding down GSEs and establishing a new regime for guaranteeing mortgages will have a modest impact on projected spending and revenues over the next ten years. The official Congressional Budget Office estimate for Johnson-Crapo and other legislation winding down GSEs may even overstate the actual budgetary savings because the subsidy cost of mortgage guarantees are calculated on a fair value basis, whereas subsidy cost under the new regime would likely be calculated under traditional credit reform rules. However, the legislation would likely produce real savings when subsidy rates are calculated on a like basis because of reforms reducing the riskiness of mortgages and therefore the subsidy rate for the federal guarantee. Those savings would likely be small in the early years, but grow over time (particularly in future decades) as the legislation phases in and legacy assets from Fannie Mae and Freddie Mac gradually fade away.

The more significant budgetary effect of GSE reform legislation is the effect on government liabilities. Reform legislation should both make hidden liabilities more transparent and reduce the size of these liabilities. The implicit guarantee for GSEs resulted in an expensive ad hoc bailout and takeover of Fannie Mae and Freddie Mac. By providing an explicit guarantee while putting mechanisms in place to insulate taxpayers from risk, the Johnson-Crapo bill provides much greater transparency and accountability in liabilities while reducing the risk of another taxpayer bailout.

Of course, the bill would still leave taxpayers on the hook after those two levels of protections, something that the PATH Act would not do. Furthermore, if the standards turn out not to be stringent enough or regulators do not adequately enforce them, the guarantee would entail some degree of moral hazard. Still, the bill would be a clear improvement over the status quo.


There are many complex and controversial issues in GSE legislation beyond the fiscal implications and the legislation will undoubtedly go through many revisions as it moves through the legislative process, but the Johnson-Crapo legislation represents a valuable step toward improving the stability of the mortgage market and reducing taxpayer risk.