How To Restructure Fannie And Freddie

Susan Woodward and John Hall are two economists who write infrequently but generally quite well when they do post something. They are out today with recommendations as to where to go with Fannie and Freddie and by implication the residential mortgage finance sector. Here is their summary of recommendations:

  1. The GSEs should be preserved, mainly because they are the most effective institutions for providing liquidity to the mortgage market.  Most mortgage investors, including depositories, prefer to hold liquid securities rather than illiquid whole loans. Wall Street securitization is not a substitute.
  2. Fannie and Freddie should be chartered as special-purpose banks, playing their historical roles of securitizing mortgages and holding some portfolio of loans.  Their debt should be federally insured or guaranteed, as are the deposits of banks, and as with banks, the equity of the institutions should be the first backup to bondholders as the capital (or equity) of banks is the first backup to deposits. Their insured or guaranteed debt should not be counted as part of federal debt, as the insured deposits of banks are not. They should be subject to capital standards and supervision of their activities, and subject to restrictions on their activities, like banks.  The capital standards, activity restrictions, and supervision need not be identical to those of banks.
  3. It is important to have two GSEs to assure competitive pricing of the guarantees on mortgages which go into MBS pools.  Guarantee fees are not posted prices, but negotiated in secret.  As a result, the pricing of guarantee fees is not collusive but  close to perfect (Bertrand) competition with two GSEs. In the trade-off of standardization and homogeneity to promote liquidity (which calls for fewer GSEs) vs. competition to assure competitive pricing (which calls for more), two gets an excellent result, likely the best result.
  4. There are three choices for F&F ownership:  1) owned by the government, like FHA and Ginnie Mae; 2) owned as a cooperative, by member institutions, as both once were, and 3) owned by the general public. Fannie and Freddie should be owned by public shareholders, as banks are.  We advocate ownership as public companies, but with explicit and priced federal backing, like banks.

They follow these recommendations with expanded arguments for their positions. It is a long post but worth taking the time to read.

There is a lot to like in their recommendations and analysis. The concept of guaranteeing the debt of the two is somewhat problematic. The analogy they draw with bank deposit insurance seems a bit of a stretch and they never do, outside of that rationale, seem to make much of a convincing argument for a federal guarantee. In some respects, their approach seems to be a retreat to the previous model with some tweaks here and there and they don’t provide any guidance around the problem of politicization that occurred with F&F. To my mind, it’s a bigger problem than they care to admit.

But, these issues aside, it is a framework for a solution. Fannie and Freddie, what to do about them and just how we are going to provide for mortgage financing is a problem that’s been put on the back burner right now. Fair enough, there are bigger fish to fry right now. It isn’t a problem that is going to go away and we might as well start thinking about it. Woodward and Hall have provided a start.

more: here


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