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09.22.2014 1

Housing collapse autopsy: A case of too little, too late

housing_MarketBy Robert Romano

“I don’t see much other than a shell game going on here, moving something from one agency to another and in the process weakening the bargaining power of poorer families and their ability to get affordable housing.”

That was then-Rep. Mel Watt (D-N.C.) in 2003 commenting on a then-Bush administration proposal to set up an independent regulator for Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac.

It is a twist of irony, then, that it is Watt who today heads up the agency that ultimately came out of the Bush proposal, the Federal Housing Finance Agency.

In the early days of the Bush White House, the U.S. Treasury under Secretary John Snow was issuing warnings about the capital adequacy of the mortgage giants. Those warnings, it would turn out, were to be prescient, and foretold the coming catastrophe in the mortgage industry, with millions of foreclosures, hundreds of billions of losses, and trillions of bailouts by the Federal Reserve and Congress.

“There is a general recognition that the supervisory system for housing-related government-sponsored enterprises neither has the tools, nor the stature, to deal effectively with the current size, complexity and importance of these enterprises,” Snow told the House Financial Services Committee at the time.

The proposal was in part in response to accounting scandals at the GSEs. Tragically, those scandals compelled Fannie and Freddie to curry favor with Congress by boosting their push for affordable housing.

Yes, you read that right. Much of the housing bubble in large part was a CYA in response to an accounting scandal.

In any event, Snow called for legislation that would have set up a new agency to oversee the GSEs. But that was not set up until 2008, after the financial crisis had already begun, and then simply to oversee the government-monitored bankruptcy of the two companies.

It took two years before congressional Republicans got serious. There was an effort by Senate Republicans in 2005 at the height of the bubble to create a similar agency, offering S.190, “The Federal Housing Enterprise Regulatory Reform Act”.  It adopted many of the Bush administration reforms Snow had outlined.

It was reported favorably out of Senate Banking Committee, which Republicans controlled at the time, and yet no floor votes were ever held. Why not?

At the time, then-Senate Minority Leader Harry Reid summed up objections to the bill, saying the legislation “could cripple the ability of Fannie Mae and Freddie Mac to carry out their mission of expanding homeownership.”

Did Reid block it? Not that the floor record would indicate if he had. Yet, considering the bill only passed out of committee on a party-line vote, it is likely if it had come to floor Democrats would have blocked cloture anyway. They were too heavily invested in the GSEs’ affordable housing goals.

As for whether the legislation would have stopped the GSEs from “expanding homeownership” had it passed, as Reid suggested, surely, it might have.

It gave the regulator the power to determine if Fannie and Freddie were undercapitalized — $187 billion of taxpayer bailouts later, it turns out they really were — and if they were, then to halt new asset acquisitions until capital requirements were met. Also, the agency would have audited the companies’ affordable housing goals, which as it turns out were at the heart of the crisis.

Later, in hindsight, American Enterprise Institute’s Peter Wallison and Columbia Business School professor Charles Calomiris in the Wall Street Journal called it “the only legislative effort that could have stopped it.”

But would it have? It is fair to say it might have stopped the expansion of the housing bubble and led to adequate capitalization of the companies, had it been adopted in, say, 2003, when Snow testified and first proposed it.

By the time the Senate took it up in 2005, many of the bad mortgages had already been made. Hundreds of billions of mortgage backed securities that would ultimately go bad were being sold to investors all over the world on an ongoing basis with the implicit backing of U.S. taxpayers.

Assuming all had gone well in the Senate in 2005, and in the House, and had made it to President Bush’s desk later that year, perhaps implementation of the agency could have begun in 2006. It would have taken time to appoint a chairman and staff it up.

And then, a thorough review per the bill’s tenants of the GSEs’ capital adequacy and affordable housing goals could have been undertaken. By 2008 at best, if the agency was nimble, perhaps it would have noticed something was amiss and found the dead canary in the mine shaft, right in the middle of the crisis.

Because, by then, it was already too late to stop the wave of foreclosures. In 2006, foreclosure filings were 1.2 million, according to RealtyTrac, and in 2007, they were 2.2 million. In 2008, there were 3.1 million. The damage was already done.

Interestingly, the 2005 bill also would have provided for the regulator to put the companies into bankruptcy if necessary: “The Agency may, at the discretion of the Director, be appointed conservator or receiver for the purpose of reorganizing, rehabilitating, or winding up the affairs of an enterprise.”

So, while it is likely the 2005 legislation would not have stopped the mortgage crisis, in 2008, instead of Congress putting Fannie and Freddie into conservatorship, the Bush administration could have unwound them right then and there.

Now, six years later, the GSEs are still in conservatorship. And the only legislation currently being considered to unwind them would simply replace the Federal Housing Finance Agency with the Federal Mortgage Insurance Corporation (FMIC).

Yes, Fannie and Freddie would be wound down under the new bill, offered by Sen. Tim Johnson (D-S.D.) and Sen. Mike Crapo (R-Idaho), but all of their assets would be given the explicit backing of U.S. taxpayers: “The full faith and credit of the United States is pledged to the payment of all amounts from the Mortgage Insurance Fund which may be required to be paid under any insurance provided under this title.”

In the meantime, the GSEs’ affordable housing goals would be replaced by FMIC’s affordable housing allocations. Here we go again.

Guess Mel Watt was correct, after all, just not about the right piece of legislation. 11 years later, the Johnson-Crapo bill appears to be nothing more “than a shell game going on here, moving something from one agency to another.” Only this time, it intends to seemingly make all of the same mistakes all over again.

Turns out, we should have listened to Bush’s Treasury Secretary John Snow when we had the chance.

Robert Romano is the senior editor of Americans for Limited Government.

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