Liddick: Mortages, magic and making money disappear
May 13, 2014
This week, the U.S. Senate Banking Committee will begin markup of another in the diligent efforts to "transform" our national economy. Note: in Washingtonspeak, "transform" can best be translated as "diligently thwart, slow, sabotage and otherwise smash."
In question is SB 1217, used as a "framework" for proposed "reforms" to government-supported secondary-mortgage giants Fannie Mae and Freddie Mac. The original bill has been gutted and its contents replaced by proposals developed by the Banking Committee's chairman and ranking minority member. That they are bipartisan only serves to illustrate that neither party pays attention to history any longer, and that both have myopia so severe they can't see next week.
The problem is not that the bill proposes to wind down government-supported entities Fannie and Freddie. These two mortgage monsters were at the center of 2008's financial hurricane, which they did much to create: through years of offering government guarantees for low- or no-down-payment mortgages to buyers with large appetites and questionable ability to pay, they built much of the house of cards whose collapse still adversely affects us. Their guarantees and funding are also textbook examples of the creation of moral hazard through government intervention in the name of "doing good." So, no; they must go. The important question is how, and SB 1217 is perverse on this.
At the moment, the bill proposes that the two GSEs simply be unwound without any compensation to the millions of American investors who hold their stock warrants. The potential loss to individuals is not a small sum; principal aside, in the past two years the firms have turned a $200 billion profit — all of it directed to the Treasury by the Administration, in repayment of the $188 billion advanced to Fannie and Freddie in 2009. Now that's been paid and then some — but the investors are still not seeing a return and they are set to see their investment vanish as well. This is a favorite Washington, D.C. magic trick: making money disappear. Those paying close attention might be reminded of the government's takeover of General Motors in 2009, in which corporate bondholders got short shrift. If this move is supposed to "restore investor confidence," it's difficult to see how.
As part of the strategy to "shift risk to the private sector," the bill proposes several changes to current practices. Although the authors note "affordability remains a key consideration," in mortgage lending, they insist that the first 10 percent of any losses on bad loans or lender failure be taken by private investors and bondholders. Institutional investors — if any — in the new Federal Mortgage Insurance Corporation created by the bill will also have to hold a cash reserve equal to 10 percent of their investment, as a cushion against economic downturn.
Underwriting standards will be strengthened: a hard minimum down payment of 3.5 percent for "first-time homebuyers" and a 5 percent minimum for everyone else. Explicit "ability to pay" requirements for borrowers and a myriad of new requirements for both loan originators and servicers. As a result, easy access to credit, typified by the no-money-down "liar loans" of the early 2000s should disappear.
Robbery of Fannie and Freddie warrant holders aside, SB 1217 proposes needed changes to the nation's mortgage banking sector. If privatizing and strengthening standards was the end of it, it would be a decent bill. Alas, this is Washington, so there is much more, none of it helpful. From the proposed composition of the new FMIC's "advisory board" to provisions about "nontraditional borrowers," concentration on "underserved neighborhoods" and a demand that lenders who fund condominiums or other "multifamily dwellings" used for rental insure their borrowers offer 60 percent of their units to "low-income families," the bill is rife with provisions that tacitly undermine its explicit intent. It is a perfect example of professional politicians' perennial desire to eat their cake and have it.
SB 1217 is schizophrenic because it fails to acknowledge a basic fact: one can either have the efficient transactions of the market, or the plodding mediocrity of the government; lending institutions properly belong to the former. While they will tolerate a certain amount of regulation and even interference, when political outcomes overwhelm good business judgment, as they did in the Community Reinvestment Act of 1999, catastrophe is inevitable; all the more so when one is dealing with an Administration as statist and populist as at present.
For proof, wait until rates rise and loans become more difficult to get, as new capital requirements, underwriting strictures and increased risk are taken into account. In less than a year, the "fairness" side of the equation will demand its due in full-throated squeal, and the rot will begin again.
Because we refuse to learn.
Morgan Liddick lives in Summit County.
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