Member FMIC: Credit-Risk Sharing Within and Without an FMIC-Based Housing Finance System

Abstract

Everyone agrees that the current chapter in the life of Fannie Mae and Freddie Mac should end. Less clear is what comes next.

Starting in the latter half of 2013, the Senate Banking Committee has explored legislation that would transform the economic and regulatory landscape of housing finance in the United States. S. 1217, the Senate Proposal introduced last summer by Senators Bob Corker (R-TN) and Mark Warner (D-VA), and revised this year by Banking Committee Chairman Tim Johnson (D-SD) and Ranking Member Mike Crapo (R-ID), seeks to replace Fannie Mae and Freddie Mac, and their regulator, the Federal Housing Finance Agency, with a “Federal Mortgage Insurance Corporation” (“FMIC”), an explicit government guarantor of conforming U.S. mortgages. The Senate Proposal would maintain a strong federal presence in housing finance but would require that private capital, through risk-sharing mechanisms, absorb the first 10% of losses. Although the proposal is unlikely to pass Congress in the gridlocked 2014 election season, it carries substantial bipartisan support going into the next Congress.

This Note explores the Senate Proposal, focusing closely on two crucial features of the proposed regulatory operation of the FMIC system: the credit-risk sharing mechanisms that the FMIC would employ and the supervision and legal duties of market participants both inside and outside the FMIC apparatus. Primarily, this Note concludes that credit-linked note deal structures provide the most efficient and prudentially safe and sound method of transferring first-loss credit risk from the FMIC to private parties. Secondarily, this Note concludes that the Senate Proposal should also include features to hasten the return of the purely private-label securitization market, such as the placement of an enhanced legal duty on private-label securitization trustees. These conclusions address broad housing finance concepts and will remain germane to the debate no matter the fate of the Banking Committee’s proposed legislation.