Housing finance reform, the great unfinished business of the financial crisis, got a push forward last Tuesday from the top Democrat and top Republican on the Senate banking committee. Chairman Tim Johnson, D-S.D., and ranking member Mike Crapo, R-Idaho, put forward a proposal to replace Fannie Mae and Freddie Mac, which currently back three-fifths of all new home loans.

Instead of those two government-sponsored mortgage guarantors, which have been under direct federal control since their collapse in 2008, a new federal entity would, in return for a fee, insure private-sector mortgage securitizers against catastrophic losses.

The private companies would put up 10 cents of their own money for every dollar of risk, and the federal insurance would cover losses above that stake, using accumulated insurance fees.

Ideally government would get out of the mortgage securitization business, limiting its intervention to a program targeted transparently to low-income, first-time homebuyers. Political realities being what they are – chiefly, the housing sector’s dependence on the 30-year, fixed-rate mortgage – such an approach is not in the cards, at least for now.

Ultimately, the quality of the underlying mortgages will determine how much exposure the government – and, by extension, the taxpayer – takes on. Poorly underwritten loans brought down both the “private-label” mortgage securities industry and the Fannie-Freddie duopoly. Yet a wide array of interest groups can be counted on to insist that standards be relaxed, bit by bit, in the name of homeownership.

Congress must resist any temptation to debase credit standards. If recent history teaches anything, it’s this: A mortgage securitization system is only as strong as its weakest borrower.

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