Today Senators Tim Johnson, D-S.D., and Mike Crapo, R-Idaho, introduced legislation that, if enacted, would meaningfully change the way that most Americans buy homes. The bill, formally known as the Housing Finance Reform and Taxpayer Protection Act of 2014, reflects an emerging bipartisan consensus on housing finance reform.
Two issues are at the core of any comprehensive housing finance reform bill:
The first promotes financial and macroeconomic stability, while the second ensures equitable access to housing, both of which are traditionally core government competencies.
The Johnson-Crapo bill makes private investors responsible for most losses (more precisely, 10 percent of first losses), providing for a government guarantee only in the case of a catastrophic scenario. To fund this catastrophic insurance, the bill requires a minimum mortgage insurance premium of 55 basis points and the insurance fund to hold capital reserves equal to 2.5 percent of liabilities within 10 years. The federal government would only be responsible for losses once the resources of the borrower, insurance fund, and capital reserves have been exhausted.
With respect to affordable housing, the Johnson-Crapo bill repeals mandatory affordable housing goals that Congress enacted in the early 1990s, but charges borrowers a 10 basis point premium dedicated to three affordable housing funds:
Below, Zillow Research outlines several key questions about the Johnson-Crapo bill.
What will happen to Freddie Mac and Fannie Mae?
Freddie Mac and Fannie Mae, together known as the Government Sponsored Enterprises (GSEs), are the two corporations that have historically owned or guaranteed roughly the middle half of all new home mortgages. (Private investors and banks own the least-risky mortgage originations, while the U.S. government has historically directly guaranteed the riskiest one-third of mortgage originations through the Federal Housing Administration [FHA] and other smaller programs.)
These guarantees allowed private investors to buy portfolios of individual mortgages through a process known as securitization, rather than assuming the substantial liabilities and risks of funding individual loans. GSE-enabled securitization helped expand the availability and lower the cost of mortgage credit in the United States in recent decades. Prior to the 2008 financial crisis, the GSEs were private corporations that benefited from an implicit government guarantee. Potentially devastating losses during the financial crisis led the U.S. government to assume ownership of the two companies. As the housing market has recovered, the GSEs have returned to profitability and have fully repaid U.S. taxpayers.
Under the Johnson-Crapo Plan, the GSEs would be dissolved over the course of five years and replaced with a Federal Mortgage Insurance Corporation (FMIC) that would perform a similar function to the GSEs. A critical difference is that the FMIC would only guarantee losses in excess of 10 percent, a threshold intended to require private investors to fully bear losses well beyond those observed during the 2008 financial crisis (estimated between 3 percent and 4 percent). Private investors and mortgage issuers would be responsible for first losses, presumably leading to more cautious lending to risky borrowers than what prevailed before the financial crisis.
Would the types of mortgages available change?
Only mortgages that meet certain standards (known as “conforming mortgages”) along a range of measures including the loan-to-value ratio, debt-to-income ratio, credit score, and geographic location are eligible for GSE guarantees. These standards allow the GSEs to more accurately assess the risks associated with each mortgage and to facilitate greater liquidity in investor markets for securitized loans.
The Johnson-Crapo Plan in and of itself would not change the range of products available to consumers, although costs are likely to increase marginally. (Mortgage costs are likely to increase independent of GSE reform as a result of the implementation of the Consumer Financial Protection Bureau’s Qualified Mortgage [QM] rules, and the Federal Housing Finance Administration’s scheduled origination fee increases.) The plan underlines the importance of preserving broad-based access to 30-year fixed-rate mortgages, although it would raise some down payment requirements (first-time buyers would still be eligible for 3.5 percent down payments, but other buyers would have a mandatory minimum 5 percent down payment) and the fees charged by mortgage insurers. In the near term, looming increases in interest rates as the Federal Reserve exits from its extraordinarily accommodating monetary policy stance of recent years are likely to have a much larger effect on consumers than GSE reform.
How does this plan compare to previous proposals?
The Johnson-Crapo Plan reflects an emerging consensus on the direction for housing finance reform. It most closely resembles a plan introduced by Senators Bob Corker, R-Tenn., and Mark Warner, D-Va last summer and echoes the principles underlying the Bipartisan Policy Center’s Housing Commission recommendations in Housing America’s Future: New Directions for National Policy, and draws key components from other outside recommendations. All of these proposals replace Freddie Mac and Fannie Mae with a federal mortgage insurance provider, continuing the federal government’s role as a guarantor of last resort in housing finance, but also increase the role of private capital in bearing the risks associated with mortgage lending.
However, the Johnson-Crapo Plan differs substantially from the Protecting American Taxpayers and Homeowners (PATH) Act of 2013 (also known as the Hensarling Plan), which was approved along a partisan vote by the House of Representatives Financial Services Committee in July 2013. The Hensarling Plan would eliminate any federal role in guaranteeing mortgage loans.
Who opposes the plan?
The Johnson-Crapo Plan was drafted by the Chairman and Ranking Minority Member of the Senate Banking Committee, reportedly with substantial input from the White House and from industry. As a result, it is likely to attract broad-based support in the Senate. However, there remains substantial opposition, primarily on the two political extremes.
Some Democrats and advocacy groups fear that the Plan does not do enough to promote affordable housing and that the reduced government guarantee will lead to cost increases that make homeownership unaffordable for many low-income Americans. At the other extreme, some Republicans strongly oppose any government guarantees for mortgage loans and would prefer to shift all housing finance functions to the private sector. In particular, they fear that establishing first-loss thresholds for private investors will not substantively change the incentives for mortgage lenders to assume risks beyond their means, particularly if they are allowed to price these risks, leaving taxpayers liable for future mortgage losses.
As is often the case in complex legislative questions requiring tradeoffs and compromise, there is some validity to both sets of concerns.
How likely is it that the plan will become law?
In the near term, the Johnson-Crapo bill faces substantial hurdles to becoming law. The current Congress has a record of enacting legislation only when confronting a hard deadline, which does not exist in this case, although investors in Freddie Mac and Fannie Mae will continue to push for some resolution as to the future ownership of the GSEs. Moreover, with Congressional elections later this year, the legislative calendar is likely to be shortened and priority given to bills with clear electoral benefits. Even if the Senate does approve the bill, the House of Representatives would then have to take up the issue. House Financial Services Committee chair Jeb Hensarling, R-Texas, has expressed a lukewarm response to the Johnson-Crapo plan and his committee has already approved a competing bill, although with almost no bipartisan support.
Looking beyond 2014, the Johnson-Crapo bill’s prospects are much more promising. The bill offers a basic framework for a bipartisan consensus with several components that can be adjusted to attract support from both the left and the right—for instance, the first-loss threshold and contributions to affordable housing and mortgage access funds. In this sense, the Johnson-Crapo bill likely provides a useful insight into how the U.S. housing finance system is likely to evolve in the future even if questions remain about the timing of those changes.
In October, prior to the introduction of the Johnson-Crapo legislation, Zillow and the Bipartisan Policy Center hosted a housing forum debating the plans, prospects and pitfalls for housing finance reform. Invited speakers included policymakers and elected officials from both sides of the aisle, and their insight and perspective remains valuable as the debate enters its next phases. To see video from our most recent housing forum, and for additional resources, please visit the event page here.