The debate over GSE reform is beginning
By Mike Konczal
As opposed to the conservative meme, the financial crisis was not simply about providing housing for low-income folks. Or even regular folks. It was a bubble-bust cycle that was in every category of credit -- CRE, credit cards, auto loans, etc. The common denominator for all of these problems was the emergence of a new lending channel that lacked sufficient risk regulation and safeguards against liquidity runs -- the shadow banking system and the originate-to-distribute private securitization lending channel that it funded.
But in the wake of the collapse, the U.S. housing market is a wreck, and nobody is sure how to fix it. On April 14, the U.S. Treasury Department released a list of seven questions to the public about the future of the U.S. housing market (criterion for each answer excluded here, in document):
1. How should federal housing finance objectives be prioritized in the context of the broader objectives of housing policy?
2. What role should the federal government play in supporting a stable, well-functioning housing finance system and what risks, if any, should the federal government bear in meeting its housing finance objectives?
3. Should the government approach differ across different segments of the market, and if so, how?
4. How should the current organization of the housing finance system be improved?
5. How should the housing finance system support sound market practices?
6. What is the best way for the housing finance system to help ensure consumers are protected from unfair, abusive or deceptive practices?
7. Do housing finance systems in other countries offer insights that can help inform U.S. reform choices?
Now people are going to begin the process of answering them. These questions are essential. The private mechanism of securitization has been destroyed, collapsed in the wake of the financial crisis and all the problems and conflicts that existed leading into it. Mortgage wealth is one of the primary means of intergenerational wealth transfer in this country. And ideally, the GSEs would provide liquidity to the housing market in the middle of a crisis (FHA has had to step in and do what the GSEs should be doing right now as the major banks have had to step back.)
I can already hear you saying, "Whatever, I'm never going to be a homeowner in the bleak 21st-century job market," but remember that all this liquidity and stabilization handles the rental market, too. Where you live. (Or your parents' mortgage or rental, if you live with them.) So there's no getting outside of this question.
Two papers are out discussing how to go about reforming the housing GSEs.
Center for American Progress
The first proposal is in this paper from Center for American Progress, "A Responsible Market for Housing Finance."
Our paper differs from proposals offered by others in at least two fundamental ways.1 First, we offer a more comprehensive vision of the housing finance system of the future, one that goes beyond only “GSE reform” (revising the government-sponsored enterprises Fannie Mae and Freddie Mac). The structural flaws exposed by the current mortgage crisis were largely -- albeit not exclusively -- found in the private-label mortgage securitization markets. Thus, any proposal that seeks to resolve the problems in our mortgage system must address the entire secondary mortgage market.
Second, while other proposals primarily aim to address the objective of liquidity -- attracting investment capital sufficient to meet the housing finance needs of U.S. housing -- our ideas are designed to fulfill a broader set of public purposes, including systemic stability and affordable housing finance.
Under this framework, privately owned and capitalized monoline Chartered Mortgage Issuers would be given exclusive charters to issue government-guaranteed MBS in order to ensure that a deep and liquid secondary market provides capital for favored mortgages. Key features of CMIs would include explicit government guarantee on MBS to ensure liquidity. The federal government would provide an explicit guarantee of the timely payment of interest and principal on MBS issued by the CMIs.
As David Min of the Center for American Progress explained to me, if you look at three goals of housing as liquidity, stability and affordability, the private market on its own has never been able to get any of them. Prior to the 1930s mortgages were scarce and the typical loan was a five-year, 50 percent down bullet loan where the homeowner would never pay down any principal (sound like a subprime loan with never paying off principal?). Major bubble-bust cycles occurred every five to seven years in the absence of countercyclical liquidity. Literally every sophisticated mortgage system in the world has a significant level of government involvement in it. Conservatives have pointed to Denmark, Canada and Germany as examples we might look to for a private system, but they ignore the fact that those countries have enormous subsidies as well as fencing, rules and regulations for how the mortgage model works.
I like this paper because it goes beyond just the GSEs and looks at the entire housing market, a scope of vision that is necessary for when the reform effort will hit full swing. It's a great place to start learning about the issues on the table for GSE reform, which will be one of the major financial reform battles of 2011.
The second proposal is from e21: Economic Policies for the 21st Century. It's written by Donald Marron and Phillip Swagel. Here's a good summary:
The two firms would become private companies that buy conforming mortgages and bundle them into securities that are eligible for government backing. The reformed firms would not have the investment portfolios that were the main source of risk under their previous structure. The federal government would offer a guarantee on mortgage-backed securities composed of conforming loans. This guarantee would be explicit, backed by the full faith and credit of the United States. To compensate taxpayers for taking on housing risk, Fannie and Freddie would pay an actuarially fair fee to the government in return for the guarantee, and the shareholders of the firms would take losses before the government guarantee kicks in. Other private firms such as bank subsidiaries would be allowed to compete by securitizing conforming loans and purchasing the government guarantee. Over time, entry into these activities would help ensure that the benefits of the government support are passed through to homeowners and would reduce the risk that the failure of any one firm would pose a threat to the housing market or the overall economy.
As Marron writes on his blog, "We were trying to fix what we see as the major flaws of the old model (lack of transparency, uncompensated taxpayer risk, misalignment of incentives), while maintaining its benefits (e.g., that mortgage credit kept flowing for conforming loans even during the depths of the crisis and that government-insured MBS are a useful asset class when the Fed wants to do quantitative /credit easing). In addition, we felt that some backstop role for the
government is inevitable as a matter of political economics and that it ought to be explicit at the outset."
Images of e21's model, before (the current state) and after:
The liquidity backstop mechanism is important. One of the obvious goals of the GSEs is the idea of being a discount window for the housing market; make it explicit that this is a goal and getting them back into that role, instead of the role of yet another drinker at the punchbowl of the credit cycle, is crucial to fixing this market.
A big question is how much they should be involved in creating conforming mortgages; would providing liquidity to private firms with more visible government subsidies just recreate the churning equity-stripping market of the 2004 for the 21st century?
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