Time for Real Home Improvement

Fixing the mortgage finance system is critical to a sustainable recovery for the U.S. housing market, and any solution goes well beyond government-sponsored enterprises like Fannie Mae and Freddie Mac.


Political consensus may be hard to come by these days, but there is no disagreement on one core aspect of the U.S. economy: The housing market is broken. As long as housing remains as critical to growth as it historically has been, without the spark of a recovery the U.S. economic engine will continue to sputter, with global consequences.

Any housing recovery will require the repair of the mortgage finance system. The assembly line of loan underwriting, servicing and securitization that worked so seamlessly for decades, helping two thirds of American households own their homes, has been dysfunctional since the 2008 crash — which, of course, the housing bubble precipitated. Residential mortgage debt in the U.S. exceeds $10 trillion, some 70 percent of gross domestic product, and one in five homeowners is underwater, owing more than his or her house is worth.

Even amid indications of improved demand in some regions, home loans would be scarce without federal guarantees. Three fourths of new mortgages, to the tune of $100 billion a month, are backed by government-sponsored enterprises Fannie Mae and Freddie Mac, which have been in conservatorship and received $180 billion in taxpayer support since September 2008. The GSEs’ losses are so great that they “cannot repay taxpayers in any foreseeable scenario,” the Federal Housing Finance Agency, overseer of Fannie and Freddie, stated recently.

There is some debate over how the housing and mortgage businesses got so out of whack. Veteran Washington lawyer and American Enterprise Institute fellow Peter Wallison has provocatively blamed the epic 1997–2007 price bubble on federal government policies promoting homeownership and leverage, exacerbated by affordable-housing mandates and Fannie and Freddie’s expansion into nonprime loans.

In a recent paper Wallison and AEI colleague Edward Pinto, a former Fannie Mae chief credit officer, drew a connection between the U.S.’s having “the most troubled housing market in the developed world” and its also being “the only developed country with a major government role in housing policy.”

Others cite lax regulation, excessive risk-taking and monetary policy as causes of the housing bust and ultimately the global credit crisis, but consensus forms around a key Wallison-Pinto conclusion: The government must give way to a more effective, private sector solution.

There are, to be sure, many moving parts that need fixing, from lenders’ capital and risk management standards to consumer protections to “increasing transparency, standardization and accountability in the securitization chain,” as the Obama administration put it in a February 2011 report to Congress on reforming housing finance. A year later, seeing “no near-term resolution in sight,” FHFA acting director Edward DeMarco included “build a new infrastructure for the secondary mortgage market” in the agency’s strategic plan for the next phase of managing the conservatorships.

“The absence of any meaningful secondary mortgage market mechanisms beyond [Fannie and Freddie] and Ginnie Mae is a dilemma for policymakers,” said the FHFA’s 2012 strategy paper.

“There is a huge amount of uncertainty,” observes Clifford Rossi, a onetime Fannie Mae risk manager who is now a teaching fellow at the University of Maryland’s Robert H. Smith School of Business. “Investors are sitting on the sidelines.” The FHFA has put forward an outline of “broad objectives” for a private market that Rossi considers promising, but, he adds, “we need a wind-down or transition strategy. We can’t just turn the lights out” at Fannie and Freddie.

Fixing the current system is important not only for public policy but for institutional investors. In a July 2011 capital markets analysis, the National Association of Insurance Commissioners cited the importance of residential-mortgage-backed securities in insurers’ portfolios and said “it would be hard to comprehend what today’s real estate market and financial system would look like” without the conservatorship.

Perhaps there would be no better cure for the current imperfections than a sustained decline in unemployment that would stimulate demand for housing, after which the necessary securitization infrastructure would fall into place. But even if the economy were so stimulated, that would imply turning back the clock to the early days of mortgage securities, a flowering of innovation under very different conditions.

To get unstuck, today’s market requires a hardened, cost-effective infrastructure that efficiently channels private capital and enhances liquidity — and is sustainable through booms and busts. Who will step up to the job? It doesn’t sound like one for government. • •

Jeffrey Kutler is editor-in-chief of Risk Professional magazine, published by the Global Association of Risk Professionals.