Friday, February 11, 2011
The White House released a proposal today that would dramatically alter the long-term future of the American housing financing market, in ways that are almost as important and fundamental as the creation of the FNMA (later Fannie Mae) in 1938.
Starting in 1938, the U.S. government created and became the most important -- and often only -- player in the secondary mortgage market. The FNMA bought loans and mortgages from banks, thereby allowing lenders to transfer the risk of default, but only if those loans met certain quality standards. The secondary mortgage market was a great success and was responsible for much of the post-war housing boom in America. The FNMA was semi-privatized in 1968, becoming Fannie Mae. It helped created the mortgage-backed securities market, but when faced with competition from other players in the secondary mortgage market who captured market share by purchasing and securitizing loans that didn't meet its quality standards, Fannie Mae lowered its standards. Because the appetite of investors for mortgage-backed securities was voracious, there was soon a race to the bottom through subprime lending. Because Fannie Mae still had special privileges with regard to taxation and borrowing from the federal government, many investors assumed or gambled that Fannie Mae would be rescued by the federal government in the event it began to crash. It did, and they were right.
The new plan's main objective is to release the United States from it's role as a de facto backstop for Fannie Mae, so that taxpayers aren't liable for reckless lending -- and presumably, so that reckless lending is less likely since liability for it will stay with lenders. It offers 3 paths to that goal, essentially gradations of the same objective -- either (1) limiting its backstop role to certain targeted borrowers (such as lower income borrowers purchasing affordable housing), who meet the previously enforced Fannie Mae quality standards; (2) limiting its role to those borrowers during a time of crisis; or (3) eliminating its backstop role entirely.
If implemented, any of these plans is likely to raise the cost of borrowing, since the risk of default must be priced into the private market system in ways that it may not have been previously. I intend to write more about the plan's implications as I have more time to study it, but it is safe to say that what is envisioned is a reduced participatory role for the government in home lending; what isn't yet clear to me is whether the regulatory role of the government will increase or decrease correspondingly.
An apparently ideologically-distasteful truth in this mess is that the FNMA worked very well from 1938 to 1968. But there is no stomach now for a government agency capturing an entire private market, even though it was able to impose quality standards that kept the market stable and functioning. Since there is no stomach to dominate the market, the question is whether any participation is appropriate. The plan's answer: perhaps, but only in the most limited sense. My concern is that in the absence of significant particpation, quality assurance can only be achieved either by extensive oversight, or by rules that cause lenders to impose quality on themselves.
Given that, I still like my half-baked idea: lenders can make loans on whatever terms they choose, but they can't sell them all on the secondary market. Instead some percentage -- let's say 20% -- must stay in-house in the portfolio of the originator. But here's the key: that 20% is chosen randomly, by some computer sitting in a government agency that knows only the loan number. It's lending Russian roulette. Lenders can decide there own risk tolerance, but they can't fully escape it. That should reduced the number of risky loans.
Meanwhile, the 80% of loans that enter the secondary market create capital for home lending.
Got another idea? Speak up -- let's get in on the conversation about the future of housing finance in the United States. If not us, who?
Mark A. Edwards
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