The mortgage finance agencies Fannie Mae and Freddie Mac will move into the Washington spotlight August 17 in a Treasury-sponsored conference designed to kick-start housing and mortgage market reforms that were excluded from the recently enacted financial legislation. But the causes of that omission, both political and practical, have hardly gone away, and Treasury Secretary Timothy Geithner is sure to have his hands full in moderating the forthcoming debates.
The Obama administration and congressional leaders concurred that the Dodd-Frank bill was cluttered enough without having to address the conundrum of Fannie and Freddie, the government-sponsored enterprises whose implicit guarantees and controversial “mission creep” have been blamed for distorting housing-market economics and exacerbating the bubble.
In the meantime, even as wards of the state that may eventually cost more than any other bailout – now approaching $150 billion and counting – Fannie and Freddie have become arguably more indispensable to housing finance than ever before, financing more than 90 percent of current home loan volume.
Recounting the omissions of Dodd-Frank, Columbia University business professor and American Enterprise Institute visiting scholar Charles Calomiris wrote in a recent paper that it “failed to address a major contributor to the housing finance boom-and-bust cycle at the heart of the crisis, namely the politically motivated government subsidization of mortgage risk in the financial system. In fact, despite the collapse [of Fannie Mae and Freddie Mac], their importance has grown.”
As a member of the Shadow Financial Regulatory Committee, Calomiris is part of a group of long-time critics of the federal housing finance structure whose views seem to have been vindicated by recent events. But unanimity is lacking, both in general philosophy and on the question of where the blame lies – Calomiris, for example, takes a critical and revisionist view of the long-lasting Depression-era banking reforms that not all economists would agree with. Even if a consensus could form on the root causes, policymakers do not face a simple set of options, and it will take time and collective patience to work through them.
Haluk Ünal, professor of finance at the University of Maryland’s Robert H. Smith School of Business, kicked off a conference of the school’s Center for Financial Policy in May by characterizing the alternative scenarios for Fannie and Freddie along a continuum between full nationalization and full privatization. The GSEs could, he suggested, be spun off as cooperatives, converted into and regulated as “de facto public utilities,” or the market could rely instead on covered-bond financing, modeled after systems in Denmark and Spain.
Also at the Smith School conference, George Washington University finance professor and former Freddie Mac and Department of Housing and Urban Development chief economist Robert Van Order put it slightly differently. “The function has to happen,” he said, and if there were no Fannie and Freddie, “we’d have had to invent them.” Realistically, he added, “Risk in mortgages will not go away. It will gravitate somewhere else.” That destination could be “something like the GSEs, banks, or private-label securities.” The latter did not look promising near-term but could be viable when markets turn around.
Any policy choice has risks, said Van Order. “The unifying theme is capital, and Fannie Mae and Freddie Mac didn’t have enough.” But a higher capital standard alone is not a cure-all, he added, because it doesn’t guarantee that regulators know exactly when an institution goes insolvent.
Among the organizations weighing in with recommendations ahead of the Treasury conference is the Washington, D.C.-based Mortgage Bankers Association, which has been discussing and developing positions on the secondary mortgage market since late 2008 and submitted its latest comment to Geithner on June 17.
“Mortgage markets will evolve over time, so the system needs to be designed with sufficient flexibility,” wrote John Courson, the association’s president and CEO, and Michael Berman, its chairman-elect.
They endorsed a continuation of traditional housing policy objectives, including promoting homeownership, stability and affordability of home financing, consumer protections and low-income subisidies. On the federal government’s role in supporting stable and affordable housing finance, they stressed that “secondary mortgage market transactions should be funded with private capital,” and that an explicit government credit guarantee “on a class of mortgage-backed securities . . . should be paid for through risk-based fees.”
Central to the Mortgage Bankers Association proposal is a new line of mortgage-backed securities consisting of a “federal government-guarantee [GG] ‘wrap’ that is in turn backed by privately owned, government-chartered and -regulated mortgage credit guarantor entities, or MCGEs.”
“The MCGEs,” according to the document, “will be required to manage their credit risk by using risk-based pricing, originator retention of risk (such as reps and warrants backed by sufficient capital to support them), private mortgage insurance and risk-transfer mechanisms including other risk-sharing arrangements, to ensure that there is a strong capital buffer before the GG and insurance fund would come into play. Loans would not be included in a GG security unless they were guaranteed by a MCGE.”
Professor Calomiris contends that the politically charged environment in the immediate aftermath of a financial crisis tends to produce hasty and flawed legislative responses – a failing he regards as common to the 1930s and the 2000s. There seems little danger that the secondary mortgage market issue will suffer from such a lack of discussion or deliberation.
