A recent economic paper envisions the end of government-sponsored entities (GSEs) Fannie Mae and Freddie Mac, whereupon their portfolios would be wound down, private investors would take a first-loss position and taxpayers would be reimbursed for financing their bailout. Experts say Washington politicians are amenable to this plan, but the fear is a mortgage market with no government backstop. This plan, however, allows for a transparent plan for government interaction in the event of another market fallout; a plan that taxpayers can review, understand and vote on so as to have some measure of control and oversight of the creation of any new GSE. For more on this continue reading the following article from TheStreet.
Housing finance experts are increasingly taking the view that the future of mortgage finance cannot exist without a government backstop.
A new paper authored by Mark Zandi, chief economist of Moody's Analytics, and former government officials from both sides of the political aisle calls for an end to government-sponsored enterprises Fannie Mae (FNMA) and Freddie Mac (FMCC), the bailed-out housing giants who now originate more than 80% of today's mortgages.
"Fannie Mae and Freddie Mac would not be part of the future housing finance system. Their investment portfolios would be wound down, their securitization activities spun out into the new platform, and their guarantee functions sold to privately funded MBS insurers. Any remaining assets would be sold. Taxpayers would be repaid (to the extent possible) for their past support of Fannie and Freddie," the authors wrote.
This largely reflects the thinking in Washington, where there is little political appetite to return the agencies back to private hands, even though both are now making record profits.
But the new system will not be completely devoid of the government's involvement. The paper instead calls for a system where private capital takes the first-loss position, while the government will step in in the event of a catastrophic failure of the mortgage market.
"In good times, when private capital is ample, private markets would provide a broad range of mortgage products with a limited government backstop. During times of severe economic stress, when private investors are unwilling to bear much risk, the government's market share would naturally expand," they wrote.
This is in fact what happened in the financial crisis. The difference is, the government's role in the future would be "explicit and transparent" so that taxpayers are compensated for their risk.
The authors consider a government backstop essential for a stable financial system that ensures borrowers get access to credit under all economic conditions. "...Though the previous housing system had serious flaws, government involvement meant that mortgage financing remained available during the financial crisis even while other parts of credit markets experienced considerable strains," the authors said. "Although costly and poorly conceived in the previous system, the government backstop eased the severity of the Great Recession that followed the subprime market collapse."
Many of the suggestions outlined in the proposal are similar to a draft bill floated by Sens. Bob Corker (R-Tenn.) and Mark Warner (D- Va.) and recommendations made by the Bipartisan Policy Center Housing Commission earlier this year.
Under the system envisaged, private, monoline insurers will bear credit risk for mortgage-backed securities. The insurers will purchase catastrophic insurance from the government for a guarantee fee, or G-fee. The government backstop will ensure that MBS investors are paid when insurers become insolvent, but the insurers will not have any kind of government backing and will be allowed to fail -- essentially private capital takes the first hit.
The government will also run a mortgage-securitization platform that builds on efforts to create a single platform for Fannie Mae and Freddie Mac securities. A common platform would ensure greater standardization, making it easier to modify loans if needed in economic downturns, the authors said. A uniform servicing standard is expected to encourage prudent underwriting as well.
The system will also have a new regulator called the Federal Mortgage Insurance Corporation that will oversee MBS insurers and the securitization platform.
"Decisions made about the future of the mortgage finance system will affect U.S. homeowners and the broader economy for decades," the authors wrote, urging policymakers to embrace the core tenets of the proposal. "Inaction also represents a decision, since leaving Fannie Mae and Freddie Mac in conservatorship means the effective nationalization of the U.S. housing finance system. Such a course would penalize American families looking to buy homes and leave taxpayers exposed to excessive housing risk."
This article was republished with permission from TheStreet.