Ten Reasons Why the "Federal Housing Finance Reform Act" is Still Bad News for Taxpayers

Revised on October 17, 2005

Note: NTU originally published this article prior to a compromise over a controversial "affordable housing fund" provision in H.R. 1461. Although this carve-out will now be used to provide low-income housing as well as benefits for victims of Hurricane Katrina, the compromise is only the proverbial lipstick on what remains a porker of a bill. H.R. 1461 still does too little to reform Fannie Mae and Freddie Mac or to protect taxpayers from a bailout that could make the Savings and Loan crisis of the 1980s pale by comparison.

Due in large part to the recent accounting scandals at Fannie Mae and Freddie Mac, Congress is now considering legislation intended to protect taxpayers and enhance oversight at the two Congressionally-chartered companies. Although the stocks of Fannie and Freddie are publicly traded, should the two housing finance giants fail, taxpayers will ultimately be left holding the bag for billions in bad loans.

President Bush has been pushing Congress to make some reforms that would lessen the likelihood of a bailout, but H.R. 1461 is not just a mediocre piece of legislation, it is an outright threat to taxpayers. Rather than creating strict oversight and limits on Fannie and Freddie, the so-called "Federal Housing Finance Reform Act" would allow these entities access to a greater percentage of the market and would do nothing to take taxpayers off the hook should they fail. Below are the top ten reasons why Congress needs to beware of this wolf in sheep's clothing.

1. Although the potential uses for the fund have changed and the program is now prohibited from giving money to left-wing housing advocacy groups, it is still troubling for one simple reason: if Fannie and Freddie are truly private companies as their advocates assert, then Congress has apparently claimed the right to arbitrarily demand 5 percent of the profits of these two companies without forcing all other mortgage lenders to pay the same tax.

2. NTU is by no means advocating a new tax on the lending industry, but it is hard to view the taking of 5 percent of any company's profits from shareholders as anything but an extremely worrisome development. This de facto tax hike signals more, not less, government meddling in the mortgage market – precisely the wrong direction.

3. The House Financial Services Committee, chaired by Rep. Michael Oxley (R-OH), disregarded calls from the Bush Administration to significantly tighten the companies' oversight and curtail their operations when it passed the legislation by a 65 to 5 vote.

4. The legislation provides an increase to $540,000 in the limit on the size of home loans that may be purchased by Fannie and/or Freddie (in some areas of the country). American consumers who can afford half-million-dollar homes do not require federal housing subsidies.

5. H.R. 1461 disregards the repeated recommendations by Federal Reserve Board Chairman Alan Greenspan, Treasury Secretary John Snow, and a growing number of researchers, that both GSEs should be gradually down-sized to avoid an inevitable systemic event when mortgage default rates return to "normal" historical levels.[1] As the chart below illustrates, mortgage default rates have fallen to historical low levels during the period of asset expansion by the GSEs.

Source: Federal Deposit Insurance Corporation. Chart shows gross and net default rates for the FDIC's mortgage specialization peer group in basis points.

6. Contrary to the claims made by supporters of Fannie and Freddie that the GSEs have helped make housing more affordable, there is growing anecdotal evidence that the "democratization of credit" financed by the GSEs is actually contributing to a rising tide of speculation in many local real estate markets.[2]

7. Mortgage default rates have sunk to levels rarely seen in the U.S. in half a century – a distortion of the private markets caused by the excessive expansion of GSE balance sheets. Trillions of dollars of mortgage holdings by Fannie and Freddie are exposed to the devastating prospect of rising mortgage default rates, whether or not interest rates rise in the short term.

8. The House legislation ignores the looming financial danger posed by the GSEs to the stability of the U.S. financial markets – in part because Members of both parties in Congress receive regular financial consideration, directly and indirectly, from the GSEs.

9. The battle over GSE policy is not a matter of liberal vs. conservative, but instead a contest between prudent reform and corporate statism.

10. The House should vote down H.R. 1461 and completely overhaul it to address many of the issues outlined above. In its current form, it is the wrong legislation at the wrong time. Should similar legislation pass both Houses of Congress without the reforms discussed in this Issue Brief, President Bush should issue a veto.



[1] Gregg Levine, "Snow: Treasury Big Follows Greenspan, Urges Limits on Fannie, Freddie," Forbes, April 7, 2005, http://www.forbes.com/facesinthenews/2005/04/07/0407autofacescan05.html.

[2] Benjamin Wallace-Wells, "There Goes the Neighborhood," Washington Monthly, April 2004, http://www.washingtonmonthly.com/features/2004/0404.wallace-wells.html.