It's all about Dodd-Frank

Posted at 8:53 AM ET, 02/11/2011

By Ezra Klein

Fannie Mae and Freddie Mac will be wound down. The government will continue to use taxpayer money to make it cheaper and safer for Americans to take out mortgages on home purchases. The administration is offering a range of options for how that commitment will be structured in the future, as they don't want to commit to any one path only to see the Republicans tear them apart for it. Those, I think, are the headlines out of the Treasury Department's new report on the future of housing finance. But I'd add one more: The implementation of Dodd-Frank really, really matters.

Beyond the basically insane structure of Fannie Mae and Freddie Mac -- private institutions with lobbyists, profit motives, and the protection of an unarticulated but widely acknowledged government guarantee to cover their big losses -- the administration's diagnosis of what went wrong in the housing market speaks much more to issues dealt with in the financial-regulation law than issues included in their three options for reform of the government's system of housing finance and insurance.

The story they tell begins in the consumer market, where inadequate protections and incompetent regulatory oversight allowed the brisk trade in bad mortgages to people who couldn't afford them to take off. It then moves to the opaque and underregulated finance system, where the banks were packaging products they didn't understand into securitized bonds and selling them off so quickly that they stopped worrying about how risky they were, and where regulators didn't see what was going on and thus didn't demand the banks hold enough capital to protect themselves from the inevitable reckoning.

Fannie Mae and Freddie Mac were part of this story, of course. But they were late to the party. They only got into the riskier stuff in 2006, while the rest of the financial industry had been playing in the mud since 2001. Reforming them can help mitigate a housing crisis in the future. But given this chain of events, it can't prevent it.

The root causes will be fixed -- or not -- in Dodd-Frank. It's up to the Consumer Financial Protection Bureau to strengthen the weak consumer protections that allowed these mortgages to be sold in the first place. Regulators will have new powers to force financial players -- particularly the megafirms whose failure threatened the whole system -- to hold more capital as a buffer against bad times. Banks won't be able sell off all their risk because the law says they have hold five percent of the risk of any product they originate -- though as Bethany McLeannotes, that's not true when the product consists of "qualifying residential mortgages," and it's up to the regulators implementing Dodd-Frank to define what a qualifying residential mortgage is.

That's not to say reforming the way the government structures its presence in the housing market doesn't matter. It does. But the government isn't looking to dramatically change the role they play in the housing market. They're just looking to get away from poorly designed institutions like Fannie and Freddie. The real action -- the work that could prevent another crisis -- is still in Dodd-Frank, where many of the questions central to how the housing markets works going forward haven't been answered, and where many of the rules that might stop it from blowing up again have yet to be written.

Photo credit: Susan Biddle/Washington Post.