As a housing policy expert, John Dalton thinks 10% hard equity from the private sector would be way more than needed to capitalize a proposed new federal mortgage guarantor.
As a Washington veteran, Dalton recognizes that a 10% requirement is table stakes for the Johnson-Crapo reform bill to gain enough Republican votes to pass.
The 10% requirement, "if not applied carefully, could jeopardize the aim of the bill," Dalton, the president of the Financial Services Roundtable's Housing Policy Council, said at SourceMedia's recent Mortgage Servicing Conference in Dallas.
"A requirement for 10% equity would make it very difficult to raise that level of capital to support the size of the mortgage market and would also greatly increase the cost of mortgages," he later said.
Of course, it all depends on what counts toward that 10%.
"I'm convinced you don't need more than 5% hard equity," Dalton told me. But the 10% requirement is acceptable as long as it does not all have to be hard equity.
"If it were 10% hard equity capital, I think it's too much. But half of it is made up of other types of capital that are more readily available," such as letters of credit, he said.
"There's enough leeway in the way the bill is written," he said. "They list a number of things that can be considered as capital."
The 10% represents what the private insurance market would be on the hook for in case of housing losses after a new secondary market structure is introduced to replace the government-sponsored enterprises Fannie Mae and Freddie Mac. The federal government would be responsible for the other 90%.
The requirement is critical for the bill to gain support of some Republican members of the Senate Banking Committee (which delayed a vote on the bill that was scheduled to begin Tuesday). "So the fact that it's 10% and has some give for what makes up that equity, I can live with it," Dalton said.
During his keynote address, Dalton said that a 4.5% capital requirement could withstand a crisis like the one that rocked the mortgage market in 2008.
There are actually four layers of protection for taxpayers in Johnson-Crapo, he noted. The first is the downpayment made by a borrower, the second is private mortgage insurance, the third is a 10 basis point user guarantee fee, and the fourth is the 10% capital provision.
Sens. Sherrod Brown, D-Ohio, and David Vitter, R-La., have proposed amendments to Johnson-Crapo that would set the hard equity capital at 6%.
Though Johnson-Crapo "is not a perfect bill," Dalton called it "the best option for bipartisan reform." He said it would provide liquidity in the mortgage market and protect taxpayers by providing for the private market to take the first losses.
The status quo, with the GSEs as wards of the government and the taxpayer at risk for housing losses, "is not a sustainable housing finance system. We must move forward on financial institution reform. I think we're sitting on a powder keg."
Dalton, a former Secretary of the Navy and former president of the Government National Mortgage Association, also touted Ginnie Mae as a potential secondary market model for a reconstructed Freddie Mac and Fannie Mae.
"Ginnie Mae has been a great program since 1968 and at no time has the government ever been called on to pay," he said. "I think the same thing can be structured in the conventional market so it too can be safe."
Johnson-Crapo's proposed new regulator, the Federal Mortgage Insurance Corp., would be structured like the Federal Deposit Insurance Corp. Dalton said his concern with FMIC is that as written it will have "overlap with existing entities."
Mortgage companies, he later said, "are concerned that as drafted the bill would provide FMIC with authority to regulate primary market participants who already have regulation from both their primary regulator and CFPB." (Just what the industry needs: Another layer of bureaucracy.)
Overall, though, "FMIC is set up well," Dalton said. "Regulation is important. OFHEO [the Office of Housing Enterprises Oversight, former regulator of Fannie and Freddie] didn't have any teeth. They didn't have the capacity to enforce. That was part of the problem."
A House version of GSE reform supported by Rep. Jeb Hensarling, R-Texas, is not tenable, he said, since it does not provide a government backstop in case of catastrophic losses. "I strongly urge addition of this provision," he said.
Mark Fogarty, Editor at Large at National Mortgage News, is starting a regular blog of analysis and commentary based on his 30 years covering the mortgage industry.