A few weeks after President Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law, Treasury Secretary Timothy Geithner hosted a public conference on the future of housing finance. Dodd-Frank had punted on that subject. Geithner was hoping to jump-start a policy discussion on the moribund $10 trillion home mortgage sector and prepare a Treasury Department review of the U.S. mortgage finance agencies Fannie Mae and Freddie Mac requested by Congress.
Geithner kicked off the August 17 gathering with a speech reviewing the histories and missions of the government-sponsored enterprises and how they had exacerbated “the general race to the bottom” that precipitated the financial crisis. He outlined options for fixes that will inevitably involve continued federal intervention even as, in his words, “we begin the process of weaning the markets away from government programs and make room for the private sector.”
Geithner acknowledged that “there is no clear consensus yet on how best to design a new system.” While industry groups have drafted blueprints and broadsides, few advocate any kind of clean, let alone radical, break.
Some have put forward what systems engineers would call point solutions, specifically targeted at, say, tightening the lax regulatory standards for mortgage brokers or using the powers of the new Consumer Financial Protection Bureau to police lender abuses. Such solutions are, by definition, not all-encompassing. Yet magic bullets may be unrealistic to expect for a system that seems to have broken down from one end to the other, from credit judgments to securitizations to the foreclosure processes that many banks recently suspended as improprieties came to light.
Clifford Rossi, Tyser teaching fellow at the Center for Financial Policy of the University of Maryland’s Robert H. Smith School of Business, estimates that mispriced risks and perverse incentives have caused the U.S. housing market to be 30 percent overbuilt, an overhang that will take years to work through.
“The situation is not getting better in the housing market — it’s getting worse,” UBS mortgage finance analyst Thomas Zimmerman said in a recent panel discussion at the American Enterprise Institute for Public Policy Research, in Washington.
“It is not tenable to leave in place the system we have today,” Geithner asserted in August. But how bold will, or can, the Obama administration be with a divided Congress?
“The really big idea would be creating a large, private secondary market for the bulk of mortgages, relying on privately set prices without the effects of government intervention,” says Alex Pollock, a former president of the Federal Home Loan Bank of Chicago and now a resident fellow at the AEI. Pollock’s view, representative of that think tank’s free-market bias, has the fresh appeal of simplicity. Pollock, among others, has also suggested that, instead of tweaking the existing system, the U.S. learn from the more-restrained housing finance approaches of Canada, Denmark and other countries that came through the downturn better than the U.S. did.
At the opposite pole, William Gross, founder and co–chief investment officer of Pacific Investment Management Co., raised eyebrows during Geithner’s August session when he suggested “full nationalization.” Elaborating in his September letter to clients, Gross said it is too late to turn back now that Fannie and Freddie are wards of the state and 95 percent of mortgage originations are government-guaranteed. Taxpayers may still be bearing systemic risk, but, Gross wrote, “Having grown accustomed to a housing market aided and abetted by Uncle Sam, the habit cannot be broken by going cold turkey into the camp of private lending.”
Between those positions, it would be hard to find common ground for compromise, unless the objective is to transition over time from one to the other.
The University of Maryland’s Rossi — who has held credit and risk management posts at Citigroup, Countrywide Financial Corp., Washington Mutual, Fannie Mae and Freddie Mac — advocates a transition, but by “holistically” addressing the ills of the home-sale market along with those of financing. He will spell out in a forthcoming white paper his goal of “getting government completely out of it,” accompanied by such innovations as a covered bond market to supply mortgage liquidity.
He would even put the mortgage-interest tax deduction on the table, steering the $100 billion-plus in additional annual revenue toward supporting first-time home buyers. Politically unpopular, perhaps even impossible, but this may be just the kind of “fundamental change” that Geithner says the administration wants to embrace.
Jeffrey Kutler is editor-in-chief of Risk Professional magazine, published by the Global Association of Risk Professionals.
