Recreating Fannie And Freddie

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As much as Congress might like to sweep the problem of what to do with Fannie and Freddie under the rug, people are beginning to talk about the need to do something and now a couple of prominent economists have put forth a comprehensive plan.

Donald Marron and Phillip Swagel have a comprehensive description of their plan at e21 and an abbreviated description can be found on Mr. Marron’s blog. Here are the main features of their proposal:

  • Fannie and Freddie once again become private firms, with the government selling off its ownership stakes.
  • Fannie and Freddie focus on bundling conforming loans into mortgage-backed securities. They buy mortgages from originating banks and pay a fee to the government in exchange for the MBS-level guarantee.
  • Securitization of conforming loans is opened to competition. Other private firms can also pay the fee and securitize and guarantee conforming MBS with the government backstop. Banks, for example, could securitize conforming MBS from their own originations or could purchase loans, including from Fannie and Freddie. Competition in the securitization industry helps to ensure that the subsidy embedded in the government guarantee is passed through to homeowners and homebuyers.
  • Fannie and Freddie have no portfolios—only a warehouse for mortgages that are purchased but not yet bundled into MBS. Strict limits are set on their activities for 5-10 years while competition develops in the securitization industry.
  • Fannie and Freddie will evolve over time into either specialized firms focused on securitization or become part of a vertically integrated financial services firm that both originates loans and bundles them into MBS. Over time, the specialized path might have the firms become like Visa and MasterCard and mainly provide network services to banks. In this model, the firms would buy mortgages from originating banks and then sell them to other firms that do the securitization and pay for the government backstop. This potential business model is built on built on the strength of Fannie and Freddie’s network ties into the thousands of originating banks and their ability to impose a screen that ensures the quality of conforming loans.
  • A federal guarantee applies on an MBS-level basis. Fannie and Freddie themselves are not guaranteed; the backstop applies to mortgage-backed securities, but only after a firm’s shareholders are wiped out. The entry over time of other firms to securitize conforming loans will make it possible for one of the firms to fail without overly negative consequences for the financial system or the housing market.
  • All special government benefits for Fannie and Freddie are repealed. The firms must register with the SEC, the line of credit at the Treasury is ended, and there is no special standing for Fannie and Freddie securities and MBS. All government-guaranteed MBS, whether from Fannie, Freddie, or other private firms, have equal standing.

There’s a lot to like here unless you happen to be a politician or believe that the federal government must continue to involve itself in housing as a matter of public policy. For that reason alone, their plan or anything similar is going to face heavy sledding.

Personally, I think it’s a good starting point. I think that we could do worse than to study the financing systems employed by other countries with an eye towards perhaps incorporating some of their techniques. The reality is that despite what we choose to believe, the Fannie/Freddie system was not all that successful even in the good times. Other countries have different approaches that rely much less on government and have achieved home ownership rates equal or better than ours. More to the point, they managed nicely not to replicate our debacle.

In many of these countries the things we are assured are absolutely vital to a successful, consumer friendly mortgage finance system are absent. There are no 30-year fixed rate mortgages with no prepayment penalties and meaningful downpayments are generally required. There may be valid reasons why other systems are not well suited to the US but it seems a worthwhile exercise to at least question the fundamental assumptions upon which we are trying to rebuild a mortgage finance system.

Maybe that’s pushing the envelope too far. Perhaps some sort of reform along the lines proposed by Marron and Swagel is as far as we can get. On the other hand, maybe getting radical is the best way to approach the problem so we can compromise back to something that amounts to meaningful reform as any real reform is going to be one hell of a knife fight.

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