Johnson-Crapo and the Future of Fannie Mae and Freddie Mac

What the Demise of this Bill Means for Mortgage Rates

Johnson-Crapo and the Future of Fannie Mae and Freddie Mac
June 20, 2014

The Johnson-Crapo Bill was intended to reform the housing market by eliminating Fannie Mae and Freddie Mac, replacing it with a different agency and new rules designed to prevent a repeat of the 2008 bailout of Fannie and Freddie that cost taxpayers $188 billion.

The idea was to introduce private capital into the mortgage-backing system in order to shield taxpayers from government losses. Recall that Fannie and Freddie were not government-controlled until the 2008 takeover. It was merely implied that the government would not allow Fannie and Freddie to fail – and indeed, that is what occurred.

Johnson-Crapo would have created a new Federal Agency in place of Fannie and Freddie – the Federal Mortgage Insurance Corporation (FMIC). The Federal Housing Finance Agency, Fannie and Freddie's overseers, would be under the FMIC's control.

FMIC would administer a fund with private money covering the first 10% of losses on the mortgage-backed securities, thus providing a buffer against future bailouts. The merits of this are arguable, as are the methods by which they are established and regulated – but one certainty is that interest rates would rise as a result. The cost of this backing capital would likely be passed on as higher interest rates for borrowers.

This in turn would make housing less affordable and result in further policy shenanigans to meet the other FMIC goal of more affordable housing. Cue the calliope music as the merry-go-round starts up again.

It is all a moot point, however, as Johnson-Crapo has little chance of becoming law. It was approved out of a Senate Committee by a 13-9 vote, but faces a rough road in the full Senate and has no chance of approval in the House. Other housing reform bills are at various stages in Congress, but they have even less of a chance of becoming law at this point.

Why is it so difficult to address this problem? One of the reasons is massive disagreement as to what the real problem is.

There is difference of opinion as to what caused the housing bubble in the first place. Was it too many loans to unqualified buyers, that these riskier loans were not dispersed properly through mortgage-backed securities to spread the risk, that the more toxic mortgage-backed securities were outright misrepresented, or some combination of those factors? More to the point, will continued government oversight help or aggravate the situation going forward?

Johnson-Crapo could arguably have made the problem worse through permanently establishing a level of government backing (unpopular among some conservatives), while setting up a system with private capital assuming risks that are capped – an open invitation for even greater risk. Meanwhile, those on the political left look at Johnson-Crapo as a means of denying affordable housing to low-income Americans, dismissing the number of poorly qualified homeowners as part of the original problem.

This bill may not have been the best solution, but if you have annoyed both sides of the political spectrum, you are arguably on the right track. Moreover, there is consensus that Fannie and Freddie must be reformed, if only from an accounting standpoint. They recently acknowledged accounting errors sprinkled through 2010-2012 adding up to almost $4 billion. Observers seem to have concluded that the errors are through deficient controls and not intentional deception, which is great news if you prefer incompetence to malfeasance.

In any case, with Fannie Mae and Freddie Mac surviving, we are likely to continue sliding back towards more available credit and riskier loans. With continued government backing of loans and a mandate to keep housing affordable, interest rates should continue to be lower than the market would normally allow them to be.

While lower interest rates are good news, the downside is that it increases the risk of repeating our past mistakes.

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