Posted on Monday, February 14, 2011
KUDOS to Treasury and the Department of Housing and Urban Development for some straight talk about the nation’s broken mortgage system.
A report to Congress from those departments, published on Friday, provided some long-awaited analysis by the Obama administration about what went wrong in housing finance — and how to fix it.
The report, entitled “Reforming America’s Housing Finance Market,” zeros in on the perverse incentives created by the nation’s mortgage complex during the years leading up to the panic of 2008. The Treasury’s recommendation that we wind down Fannie Mae and Freddie Mac and let the private mortgage market step in is spot on.
Still, it is not clear that such moves, sensible though they are, will be enough to prevent taxpayers from having to bail out institutions that back mortgages in the future. That is because the debate over how to put the Treasury’s ideas into effect will soon become a brawl. Powerful participants are already working overtime to keep taxpayers on the hook.
The financial services industry, after all, has grown accustomed to having taxpayers ride to the rescue when it gets into trouble. Why would the big banks want to change that wonderful (for them) dynamic?
Some mighty and diverse groups are lining up against significant reductions in the government’s role as backstop to the mortgage industry. These include the Mortgage Bankers Association, the Financial Services Roundtable and the Center for American Progress. All three have put out recommendations revolving around the notion of creating Fannie- and Freddie-like entities to guarantee mortgages.
Never mind that we have seen this movie before, and that it ended badly.
The Mortgage Bankers Association, for example, recommends the creation of “mortgage-credit guarantor entities” with federal charters and overseen by a federal regulator. These private entities would guarantee loans pooled into mortgage-backed securities, just as Fannie and Freddie did. At least one of these institutions could be owned by mortgage originators in a cooperative set-up, the mortgage bankers say.
In a report issued last month, the Center for American Progress echoes this plan, calling for the creation of mortgage institutions with federal regulators and charters to guarantee mortgage-backed securities.
But because, under both plans, mortgage lenders could own some of these institutions, the entities could become new, too-big-to-fail constructs. What would stop the banks from assigning high-risk mortgages that they originated to these guarantors, once again leaving taxpayers to pay the freight if the loans go bad?
Sure, these entities would be overseen by a “strong regulator,” as the Mortgage Bankers Association asserts. But if the credit crisis demonstrated anything, it was how easily regulators can be co-opted by the enterprises they are supposed to oversee. And if the mission of these “new” guarantors includes affordable-housing goals, you can be sure that regulators will again be persuaded to let them take more risks in the name of meeting homeownership benchmarks.
Happily, the Treasury report helps identify these possibilities when it describes how the taxpayers came to own Fannie and Freddie, at a current cost of about $150 billion. For example, the report states that the “profit-maximizing structure” at Fannie Mae and Freddie Mac undermined the companies’ public mission, while their perceived government backing conferred unfair advantages. It is hard to see why the new entities recommended by the financial industry, especially when they are owned by banks, would not have these dangerous characteristics as well.
Lest we forget, Fannie Mae and Freddie Mac were simply supposed to support liquidity in the mortgage market, according to their charters. They did not require the companies to actually add cash to a world already awash in home-loan money. But because executives at both companies wanted the lush profitability that such financings provided, Fannie and Freddie wound up pouring more liquidity into a system that did not need it.
That is the lesson of the financial crisis, at least where Freddie and Fannie are involved. Taxpayers surely do not want to create new government-sponsored enterprises that may later fail. So why not work toward a system where the government is solely the home lender of last resort? That way, the private market could operate in good times; the government would step in only if the market froze up.
Friday’s report seems to be leading in this direction. But it supplies no road map to a government system that provides a catastrophic insurance program only for those times when the private market is not working.
Such a program could insure privately underwritten mortgage securities at a cost based on in-depth analyses of loans in these pools. Using actual loan files, program administrators could estimate both current and historical losses of mortgages in the pools and base the cost of the insurance on the securities’ true risks. Insurance fees should not, repeat not, be based on credit ratings.
To be sure, any honest discussion of a new deal in mortgage finance will probably conclude that home loans would become more expensive. But if people put down more money when they bought homes, the risks associated with their mortgages would, in theory, be lower. As a result, their mortgage costs would decline, reflecting those lower risks.
And while we are talking honestly about mortgage finance, we should recognize the dire consequences of our nation’s tax policy, which encourages consumers to amass huge levels of debt when buying a home. Why not reward borrowers who have more equity in their homes instead?
One way to do this would be to provide tax credits to borrowers based on the amount of their down payments. Such a system could be graduated so lower- and middle-income borrowers benefited most, while upper-income borrowers received far less or nothing at all.
There is much to hash out if we are to build an effective housing finance system in America. Being truthful about what went wrong in the past, the report paves the way for a meaningful discussion. But we must also be sure that the solutions do not bring us back to where we began. That is where the real fight will be fought.
By GRETCHEN MORGENSON, THE NEW YORK TIMES