By: David Loesberg*

The Senate Committee on Banking, Housing, and Urban Affairs (Committee) is currently preparing to move its key legislation, the Housing Finance Reform and Taxpayer Protection Act of 2013 (Corker-Warner), out of committee.  Corker-Warner proposes an entirely new housing finance market distinct from the market that caused the Great Recession.  The housing market collapse crippled the American economy, stripping the housing finance market of investor confidence and providing little recourse for the average American consumer.  Congress must now dictate its own engagement in the new marketplace, both as a regulator and as a participant.  Its decision will reverberate across the domestic housing market and the international finance industry.

Corker-Warner attempts to resolve a complex issue in an unprecedented manner.  The Committee plans to revoke Fannie Mae and Freddie Mac’s current duopoly over the housing finance market and replace it with the Federal Mortgage Insurance Corporation (FMIC).  The FMIC is tasked with overseeing the mortgage-backed securities market while “protect[ing] the taxpayer from having to absorb losses incurred in the secondary mortgage market during periods of economic stress.”  Housing and Economic Recovery Act of 2008, Pub. L. No. 110-289 § 101(b)(2) (2008).

The housing finance market has improved since the initial collapse.  However, the federal government currently backs nearly all new mortgages, which places the risk of a crash on taxpayers that will continue until Congress implements significant reform to the secondary mortgage market.  If enacted, Corker-Warner will create the FMIC, a federal agency that will absorb most of the FHFA’s power, responsibilities, and capital, while eventually abolishing the GSEs.  Housing Finance Reform and Taxpayer Protection Act of 2013, S. 1217, 113th Cong. § 201, 301-303 (2013).  Corker-Warner calls for a five-year transfer from the GSE conservatorship to the FMIC.  Id at § 2(16).  Once established, the FMIC will become the primary regulator for the housing finance market.  Id at § 201-203.

The FMIC is not adequately prepared for future market conditions.  Corker-Warner’s proposed structure assumes current marketplace trends will continue.  This is an incorrect assumption.  The marketplace will become less predictable once the FMIC acquires the GSEs.  Corker-Warner calls for the FMIC to absorb the GSEs’ assets following their eventual dissolution.  The future transition is more complicated than the Committee originally expected.  It mandates the GSEs liquidate most nonessential assets and divisions, and conveys the GSEs’ multifamily mortgage divisions unchanged to the FMIC.  Although these plans are likely boilerplate language placed in Corker-Warner until the Committee creates a better structure, they are still “neither legal nor workable.”

Investors currently feel safe participating in the marketplace because taxpayers bear an overwhelming majority of the risk.  In the new marketplace, the FMIC will not guarantee a return on investment if the investor fails to place ten percent of their capital in the first-loss position.  Shifting the risk towards investors creates a less-predictable marketplace because investors will be less willing to participate.  The Senate must better prepare the FMIC for future variables, such as investor reluctance to participate, rather than base future market structures on current and past conditions.

Corker-Warner must allow investors the necessary time to acclimate to the new regulatory structure.  Under the current act, the FMIC must operate at full capacity “not later than 5 years after the date of enactment of this Act.”   This statutory mandate is shortsighted.  The FMIC will not possess the necessary flexibility to postpone its initiation unless Congress grants it this power.  Congress cannot foresee whether investors will immediately participate in the new marketplace.  Investor confidence will likely subside upon the FMIC’s entry into the MBS market.  Most investors may adopt a “wait-and-see” approach towards investing in the new marketplace, making few initial investments and analyzing movement through the regulatory structure.  Congress can provide the FMIC with the necessary flexibility by enumerating objectives that it must achieve before full market initiation.  The mortgage industry will likely scrutinize the FMIC throughout its infancy.  Congressionally mandating the FMIC to achieve objectives will bolster investor confidence by displaying the FMIC’s capabilities to the mortgage industry.  Thus, investors will maintain confidence in the MBS market if Congress provides the FMIC with objective-based mandates rather than time-based deadlines.

Some Senators on the Committee have expressed opposition towards eliminating the five-year mandate.  Senators Crapo and Warner fear withholding the FMIC’s initiation into the MBS market longer than it already has been withheld.  The Senators believe that replacing deadlines with objectives is problematic because objectives can shift as time progresses.  Yet such reasoning automatically presumes the false assumption that congressionally mandated deadlines will remain constant.  Crapo further emphasized that objectives lack the assurances that deadlines provide the marketplace.  Although marketplace assurances are a valid concern, the Senate should provide objectives rather than mandate a deadline.  The Committee should not risk introducing the FMIC into a marketplace devoid of willing investors when ten percent of America’s GDP is at risk.

The Committee should provide logistically vague objectives for the FMIC so it can maintain optimal flexibility in entering the marketplace as the primary regulator.  Statutory language can mandate that the FMIC achieve these objectives but would not constrict the agency in achieving them.  This grants the FMIC the necessary flexibility to ensure the near five trillion dollars in MBSs currently managed by the FHFA is not mismanaged during the transition.  Vague objectives should ease the Committee’s fear of another weak regulator in the secondary mortgage market.  The enumerated objectives will be clear in both legislative intent and expected achievements.  The FMIC should be successful in regulating the market with these objectives and vague logistical mandates because it will be implemented by housing finance technocrats who, unlike Committee members, have decades of experience in MBS regulations.  These technocrats will direct the FMIC to achieve the enumerated objectives without damaging the deep liquidity necessary for the secondary mortgage market to continue its primary objective: provide Americans with the ability to own their homes.

Mandating that the FMIC become fully operational within five years of Corker-Warner’s enactment could slow the secondary mortgage market and cripple the FMIC before it begins.  The Committee based its current estimates of future market performance on current market data.  This assumption endangers the FMIC because the FMIC must enter the marketplace five years after Corker-Warner’s enactment, regardless of market conditions.   The FMIC’s introduction into the marketplace could deter market participation.  If this occurs, the FMIC may not be fit to handle the market conditions because Corker-Warner assumes the FMIC will enter into market conditions similar to the present FHFA run market.  The Committee can easily resolve this issue by providing the FMIC with the flexibility to dictate its own entry into the marketplace by enumerating objectives and providing vague logistical directions.  Granting the FMIC’s technocrats the flexibility to achieve the Committee’s objectives will allow the FMIC to ensure borrowers can obtain affordable mortgages.

It is for the above reasons that the Committee must grant the FMIC more flexibility in its introduction to the marketplace.

*Note: The author has left out citations to sources not available to most readers.  Please contact the author to request the fully cited version of this article.