The Johnson-Crapo Bill: More Of The Same Crony Capitalist Housing Scam

You could have predicted this. For five long years after the nation's devastating housing disaster, Washington did nothing about those $5 trillion twin culprits---Freddie and Fannie. Now, just as the housing market is beginning to rollover again because the "flash" boom stimulated by the Fed's free money gift to the buy-to-rent LBO funds has run its course, the Senate is rushing to pass a GSE "reform" bill.  Indeed, a couple more bad reports like the March housing plunge and the beltway bandits will be jitter-bugging all over Capitol Hill, claiming that GSE reform is vital to getting the housing rebound back on track.

How many times are they going to fall for that malarkey? The now pending Johnson-Crapo bill is just the same old crony capitalist scam. In truth, the GSEs are nothing more than beltway store fronts----a façade behind which Wall Street and the assorted branches of the housing finance lobby---realtors, mortgage bankers, mortgage servicers, mortgage insurers, property appraisers, homebuilders and countless more---scalp windfall rents from the public credit. That is, they all feast on bits and pieces of the giant subsidy that is implicit in the very notion of a Government Sponsored Enterprise or GSE.

Just a brief reflection will remind you that these wasteful, unfair and economically destructive institutions are merely branch offices of the US Treasury in disguise. Without the full faith and credit of the American taxpayers behind them, trillions of debt and securitized mortgage paper guaranteed by Fannie and Freddie would have taken severe haircuts in the summer of 2008. Their day of reckoning was avoided only because Wall Street's plenipotentiary in the US Treasury Building, Hank Paulson, threw them a life-line(and the taxpayers under the bus).

Then and there all the billions of phony accounting profits the GSEs had booked over the years to feed Wall Street speculators---who had driven the market cap of Freddie and Fannie to the absurd height of $150 billion---went up in smoke. The fact is, had the GSE's been paying the Treasury a fee equal to the full value of its implicit guarantee over the years, and had the GSEs been required to set aside full and honest insurance reserves for the loss risks embedded in their then $6 trillion portfolio, they would have been forever unprofitable and inherently insolvent.

The reason is simple. The GSEs provide no economic value-added whatsoever to the American economy. As should be now painfully evident, aggregating mortgage underwriting risks into multi-billion Freddie/Fannie securitized  pools does not reduce risk one iota; it just hides and obscures it.

Likewise, it does not make mortgage finance cheaper and more efficient; it just causes securitized GSE paper to be underpriced--resulting in windfall rents to the crony capitalist mortgage processing industries and unfair subsidies to the small fraction of American households who manage to get a GSE "qualifying" mortgage. But regardless of how the subsidy is ultimately whacked-up, all the "vig" in this lamentable chain comes straight from the taxpayers---most of them unwitting and yet to be born.

In truth, the US economy could thrive just fine without subsidized 30-year fixed rate mortgages, and if that led to a drastic fall-off in the rate of home ownership---so be it.  Germany seems reasonably prosperous by present day standards, yet its homeownership rate is only about 55% or well below the sharply reduced 65% rate that pertains in the post-crisis US market.

Stated differently, if a transparent GSE reform bill was ever presented to the Congress it would never get out of committee. The Republicans would vote against it---and properly so---on policy or ideological grounds. And the Democrats would be indifferent because not a single element of the K-Street housing lobby would be in favor.

Let me explain. If we want the state to guarantee everyone's mortgage, then let the program be run transparently by a handful of GS-15s in the Treasury Department and a giant server farm to process all the paper. That way there would be no feasting on the resulting multi-billion credit subsidy by Wall Street and its infrastructure of housing finance cronies.

Likewise, the true economic losses from the inevitable mortgage borrower defaults would be paid for by what are by the lights of Washington apparently the "deserving" parties. That is, the losses would be covered by Federal taxpayers who are also renters, debt-free homeowners and even those mortgage borrowers with Treasury guarantees who stay current. In essence, that's what happens now---but its all obscured and hidden behind the phony rigmarole of GSE agencies.

Needless to say, the Bureau of Mortgage Guarantee Bill would get zero traction in the beltway. The housing lobby would even denounce it as "un-American". Imagine that---Washington handouts made in plain sight, not obfuscated by the machinery of crony capitalist larceny!

But, alas, it is not reasonable to expect Washington to notice anything in plain sight. After all, there is a loud chorus now proclaiming that the GSE's have earned the right for a life extension because the have paid back the US Treasury every dime they borrowed----about $180 billion to be exact.

Lets see. More than $60 billion of that was accounting magic---the reversal of a tax loss provision that was written-down a few years ago and is now being written-up. And the balance is the same old underlying scam. They are not real economic earnings ---just accounting profits. They reflect doing nothing except not paying the US treasury for renting its credit rating and not charging their income statements with the full loss reserves that history has already proven are absolutely certain to recur when housing prices take their next plunge southward.

So there is an easy way to identify true GSE reform. Unless it closes the doors at Freddie and Fannie, fires their over-paid apparatchiks and puts their existing portfolios in a purely run-off mode, it is not reform. Not surprisingly, leading the anti-reform charge is Senator Mike Crapo---another purported "conservative" who doesn't know the difference between free enterprise and crony capitalism.

The always cogent Chris Whalen provides further commentary on the Johnson-Crapo scam below.

By Chris Whalen

Advocates of the legislation are pushing hard to get the bill out of committee and to the floor of the Senate this year. However, frankly, the "reform" proposal falls short in a number of respects, most notably that it will simply create another monopoly in the world of housing finance for the government and largest lenders.

Strangely, supporters of Johnson-Crapo erroneously compare the FMIC to the Federal Deposit Insurance Corporation, an industry-funded mutual insurance scheme and prudential regulator that is nothing like the proposal the Senate Banking Committee will consider. A more apt metaphor is the existing model provided by the FHA and Ginnie Mae, two of the oldest and most important of the housing GSEs.

Thankfully, even were Johnson-Crapo to pass the Senate, its prospects in the House are dim at best. House Financial Services Committee Chairman Jeb Hensarling (R-TX) has authored his own housing overhaul legislation which would call for a drastically reduced role for the government in housing.

However, the conflict of visions between the House and Senate when it comes to housing is just the beginning of the problem.

A big part of the reason that meaningful housing reform is so difficult to achieve in Washington is that the industry is heavily subsidized and has been for decades. Housing industry lobbyists oppose any meaningful reform; realtors, homebuilders, lenders, and major Wall Street firms want continued government backing of mortgage loans and securities.

The supposed private shareholders of Fannie and Freddie, for example, including some of the most prominent Wall Street hedge funds and consumer advocates like Ralph Nader, want Congress to make them whole on their “investments.” They don’t care that taxpayers continue to shoulder the real liabilities associated with these ersatz housing agencies.

Private investors have never carried even a tiny fraction of the risk in housing going back to the Great Depression, in part because the risks of this $10-trillion market are too large. Fannie Mae and Freddie Mac are reporting record profits, all of which must be turned over to the US Treasury under the conservatorship that was put in place after the 2007 subprime crisis.

However, are the GSEs really profitable?

If you consider the vast subsidies pumped through Fannie and Freddie via government programs like Home Affordable Modification Program (HAMP) and The Home Affordable Refinance Program (HARP), and the interest rate subsidies from the Fed, not only do the supposed profits disappear, but neither agency is really solvent.

Factor in the additional subsidies via the Fed’s low-interest rate regime and the purchase of mortgage securities under “quantitative easing,” and the profitability of Fannie and Freddie becomes even more suspect. We have not even talked about the billions of dollars’ worth of foreclosed homes owned by each agency that are carried at “cost” under bizarre federal accounting rules.

Yet much of the thinking on Capitol Hill behind the Johnson-Crapo proposal is predicated on the fallacy that the GSEs actually make money. Indeed, if members of Congress bothered to read the latest earnings reports from the major banks, they would discover that lenders are losing several thousand dollars on every mortgage they make.

Both HAMP and HARP were massive subsidy programs for the banks and the GSEs which underwrite more than 90% of all mortgages in the US. The purpose of these programs was to kick the proverbial can down the road and buy time in the hope that the rising tide of a recovering housing market would lift all boats. Unfortunately, with home prices now starting to peak and even fall in some parts of the country, redefault events on subsidized loan modifications and refinancing are increasing “at an alarming rate,” according to the Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP).

"The longer a homeowner remains in HAMP, the more likely he or she is to redefault out of the program," SIGTARP states in its most recent report to Congress. The redefault rate among the oldest HAMP mortgage modifications is almost 50%. Moreover, many loans modified or refinanced at subsidized interest rates are now resetting to market rates, a fact that will drive defaults on HARP and HAMP loans steadily higher.

The whole process surrounding reform of the government role in housing has a certain fantasy-land atmosphere. Supporters of a strong government role cannot bring themselves to admit that the massive subsidies used to prop up home prices since the 2007-2009 subprime crisis must eventually come home to roost. Conservatives who want to see a reduction in the government role in housing don’t seem to appreciate what will happen as and when they get their way, namely a sharp reduction in mortgage lending volumes and home prices.

The Johnson-Crapo proposal represents the status quo in a new guise, but the real question that members of both parties in Congress need to ask is whether maintaining the status quo is even possible. The apparent stability in the US housing market is a function of massive subsidies, something that neither Democrats nor Republicans seem to understand. As the election approaches and home prices begin to fall later this year under the weight of a bad job market, flat to down consumer income, and rising interest rates, the political debate is likely to shift from reform of the government’s role to how to pump yet more subsidies into the housing sector.



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