GSE Reform Legislation: It Ain’t Over Yet

Legislation to reform the GSEs, Fannie Mae and Freddie Mac, is a hot legislative topic this year for mortgage lenders of all sizes.


Legislation to reform the GSEs, Fannie Mae and Freddie Mac, is a hot legislative topic this year for mortgage lenders of all sizes. If you are the largest of the industry’s lenders, it is a fair bet you are fully supportive of most every provision in both the House and Senate bills. Both were reported out of committee this summer.

If, on the other hand, you are not one of the industry’s giants (and most of us are not), then you either are or should be concerned about the provisions in both bills that are not directly related to regulatory and capital reform.

In Case You Missed the Earlier Episodes
A little background might be helpful. Early in this legislative session, Senator Chuck Hagel (R-NE) introduced S. 190, the Federal Housing Enterprise Regulatory Reform Act of 2005. Hagel’s bill introduced several provisions with which no one can argue: creation of a single, stronger regulator for the GSEs, and flexible, regulator-managed capital requirements. Since Fannie Mae and Freddie Mac are charged with providing a steady supply of capital for housing finance, these provisions are enjoying broad-based support. Other of the bill’s provisions, however, fundamentally change and negatively impact the ways in which smaller lenders such as credit unions will access the secondary markets.

Meanwhile in the House, Congressmen Richard Baker (R-LA) and Michael Oxley (R-OH) introduced HR 1461, the Federal Housing Finance Reform Act of 2005. Similar in nature to Hagel’s bill from a regulatory and capital perspective, it too contained provisions that severely restrict the ability of credit unions to meet their members’ needs for housing finance.

The House Bill was reported out of committee in June with the Bright Lines provisions largely intact. More on that in a minute. Mark-up on the Senate Bill was completed just before the summer recess. Along a straight party-line vote, among other things, it eliminates Freddie Mac’s and Fannie Mae’s portfolio. Read on to learn why this is troublesome.

Why Worry?
Credit unions should be concerned for three reasons:

  • Bright Lines: Bright Lines made its debut in the Hagel bill. Seeking to clarify the GSEs’ permissible activities, this section of the Senate legislation quite simply eliminates Loan Prospector™ and Desktop Underwriter ™ from Freddie Mac’s and Fannie Mae’s offerings.

    What decisioning technology will the industry use? Large lenders will build or have already developed their own technology. Smaller lenders will have to buy these systems from their larger counterparts at what are sure to be highly competitive prices, a situation which will put credit unions at a disadvantage. When smaller lenders are negatively impacted, so are the borrowers they serve. The cost of financing a home will rise.

    There is another consequence: the standards to which the industry underwrites will disappear. Disparate impact, all but eliminated thanks to the GSEs, will return once again. And, if borrower discrimination isn’t bad enough, consider what becomes of mortgage loan sale-ability. Without a single underwriting standard upon which investors can rely, how will loans be marketed? Myriad approaches to underwriting will result in highly inefficient secondary market transactions, which, in turn, will result in a higher cost of financing. Once again, the cost of a mortgage will increase.
  • Prior Approval: Before bringing anything new to market, the GSEs will be required to receive approval from their regulator. The regulator may further decide that new ideas should be published in the Federal Register for public comment. Billboard and radio spots would be a faster, more cost-effective way to give away intellectual capital. Ludicrous as this sounds, the result is the same. Suffice it to say, thanks to this provision, the mortgage markets will be stuck in innovation purgatory. Since recent product development has been focused on affordability, this, too, will have an adverse impact on housing.
  • Portfolio Limitations: Congressmen Baker and Oxley’s Bill introduced the idea of limiting the GSEs’ portfolios. While there is still language in the marked-up version of the House bill, it makes an industrial-strength appearance in the Senate version. It doesn’t simply limit the portfolios, it eliminates them.

Implications for the US Housing Market
This is a bad omen for the US housing market. And I can give you at least four reasons.

First, neither Freddie Mac nor Fannie Mae will be able to perform the basic function of their charter: to provide a consistent source of capital to the housing market. Will the private-sector step in, you ask? Yes and no. While the private sector will provide capital under most conditions, in times of domestic or international financial duress, recent events suggest that the private sector will severely curtail lending until a sense of normalcy returns. Remember the 1998 Russian and Asian financial crises that threatened market liquidity? The GSEs helped to shore up the markets. In the terrible aftermath of September 11, 2001, Fannie Mae and Freddie Mac remained open while the US private markets shut down. There will inevitably be another crisis. Who will step in for the next crisis when the GSEs cannot?

Second, while the housing market is busy financing $2.3 trillion per year in housing transactions, it will have to absorb another $1.4 trillion as Fannie and Freddie sell off their holdings. Harken back to your days in Econ 101. When demand exceeds supply, prices rise. During the sell off, mortgage interest rates will rise and housing will become less affordable. Post sell-off it is unlikely mortgage rates will return to their previous lows. It is a simple supply and demand equation.

Third, as the cost of financing a home increases, the demand for housing decreases as homes become less affordable. Housing prices will slump, wiping out billions in homeowner equity. The US will return to being a nation of renters.

Treasury Secretary John Snow, in testimony he gave to Congress on this topic earlier this year, believes eliminating the portfolios is a bad idea for the reasons stated above. We agree.

Fourth, the GSEs use their portfolios for liquidity and as a means to launch new mortgage products. Products such as the 40-year mortgage did not have a secondary market when introduced last year. No matter. Fannie Mae placed these loans in their portfolio until investors figured out how to fit them in their own portfolios. Here is yet another example of how the legislation adversely impacts the cost of homeownership.

What Can You Do?
Educate your lawmakers, especially Republican Senators, about why the non-regulatory and non-capital provisions of the GSE reform bills are bad public policy. Enacted into law in their present state, these bills force credit unions to work directly with big banks—their competitors—for mortgage liquidity. The big banks, not coincidentally, are the mini-skirt wearing, pom-pom waiving cheerleaders providing the rah-rah for this Congressional game. To them it’s just one more covert way to prosecute Operation Credit Union. Banks have everything to gain. Credit unions and homeowners have everything to lose.



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Aug. 29, 2005


  • I just stumbled on this page while searching for articles talking about the origin the housing bubble and subsequent crash.

    You got what you wanted and stopped reform legislation in 2005. How did that work out for you?
  • I am a Mortgage CUSO CEO. You hit the nail on the head. The large banks want to eliminate the tools FNMA and FHLMC provide. We will either have to do without, or buy their proprietary products. Either way we, and our members, lose big time. We have dropped out of the Mortgage Bankers Assoc because of this. They support this because their large constituents do. Dave Toepp-Mortgage Center
  • Extremely thought provoking. Great info.
  • If this issue was a consumer loan issue, credit unions would be in the streets protesting. I fear because it is a mortgage lending issue, creit unions will be "asleep at the wheel."
  • This article is long over due. The one issue that you did not cover is the provision for "high-cost" areas contained in the house bill and not in the senate. Currently Hawaii, Alaska, Guam and the Virgin Islands have a 50% higher conforming loan limit. Tnis limit needs to be extended to all areas of the country where real estate prices far exceed the national average.
  • The market will create better underwritng standards then the GSEs ever could. There is no underwriting standard today, what there is are a couple of underwriting monopolies - a monopoly is not a public standard.