Published for CNBC.com, February 11th, 2011:
If we could go back in time, decades ago we would have phased out Fannie Mae and Freddie Mac — the two government controlled housing finance agencies — allowing for a wholly private secondary market for mortgages to develop. But we don’t get to go back in time and instead need to deal with the hopelessly imperfect system we have today.
Reforming this system has to reflect two key realities:
1. Fannie and Freddie exist, and in a big way — with huge portfolios of mortgages, including about 90% of all new mortgages originated since the financial crisis; and
2. The government has shown — and investors rightly believe — that it will step in to support housing finance should another crisis emerge.
However much many of us would like to see a strictly private role for mortgage securitization, Treasury Secretary Geithner’s options rightly reflect these two realities.
The Geithner plan has the right goal: private markets – subject to strong oversight and standards for consumer and investor protection – should be the primary source of mortgage credit and bear the burden for losses. The private sector, not the government, should be the dominant provider of mortgage credit.
The plan appropriately removes the affordable housing mission from the securitization business, and places those goals squarely in government agencies designed by Congress to meet that mission — like the Federal Housing Administration, while also focusing that agency’s footprint.
Because Fannie and Freddie so dominate the mortgage securitization market today, a rapid move to dissolve them would significantly endanger our still fragile domestic housing market and inspire doubts among current participants in the housing agency securities market. So the plan wisely calls for a deliberate, yet determined path to transition to a largely private housing finance system.
Critics of the Geithner plan — Realtors, mortgage bankers, home builders — will predictably argue that these reforms would raise the cost of mortgages. They’re right. I don’t know if these critics noticed, but we just had a housing bubble marked by irrationally cheap credit that led to dangerous excesses in housing finance. Marginally higher rates for mortgages is the essential cost for a rational, safer, market-based housing finance system that limits taxpayer exposure. Housing finance was grossly underpriced — at least until taxpayers had to ride to the rescue.
To achieve Secretary Geithner’s goals of a largely private market for housing finance, he presents three options: very limited support for targeted groups of borrowers; a guarantee mechanism that would scale up in times of crisis; or, basically, a reinsurance program for a targeted range of mortgages.
In the coming months we’ll debate the pros and cons of each of the Treasury options — none are perfect — but it’s important to note that each would significantly scale back the role of government’s footprint the mortgage market and limit the risk of taxpayer exposure to losses. Given the housing finance system we’re left with today, the Treasury plan is the right place to start the reform debate.