There is Time to Fix the GSEs – Use it Wisely

John Dalton, the president of the Housing Policy Council, might have had us in mind in a blog in Housing Wire this week in which he sought to try to dispel the notion that creating a larger role for private capital in housing finance would not mean ceding control of this sector to the “big banks.”  However, it is hard to see how his vision of a reformed housing finance system would do otherwise.

The HPC is an arm of the Financial Services Roundtable so Dalton’s ideas for a more robust role for private capital comes as no surprise and, on their face, may sound reasonable. He wrote:

“A reformed system can include new privately capitalized firms to back the mortgage market and fill the role that Fannie and Freddie currently perform, but at much less risk to the taxpayer.  These privately capitalized entities would not be controlled by large banks and would guarantee mortgages originated by lenders of all sizes. These guarantors would be supervised by a federal regulator and they could not be owned or controlled by another company. These well-regulated private companies would also support owner-occupied and rental housing for extremely-low and very-low income families by contributing to housing funds.”

However, his policy prescriptions raise the same questions we have asked repeatedly.  Even if the GSEs are dismantled, won’t it be necessary to rebuild entities that are very similar? Where would the capital come from? And what is in the best interest of the taxpayer?

Fannie and Freddie are private companies with government charters. They back up some $5 trillion worth of mortgages. How would we create privately capitalized entities large enough to duplicate the success of Fannie and Freddie in maintaining countercyclical liquidity in capital markets? Dalton or someone from the mortgage banking sector needs to answer questions former Federal Deposit Insurance Corporation Chairman William Isaac raised in an article in American Banker several months ago.

Even if we put aside this important question and assume it would be possible to shift the function of Fannie and Freddie to comparable, privately-capitalized entities, it would be critical to fully understand how a regulatory structure could be created and sustained so as to prevent them from being owned or controlled by another company – a Too-Big-to-Fail bank.

To be sure, lapses in regulatory policy plus distortions in the GSEs’ mission Congress and several Administrations helped create in the years leading up to the 2008 financial crisis suggest that a new regulatory model is worth considering. Giving the unique mission of the GSEs, the successor entities Dalton envisions would function almost like public utilities. Therefore, strict guidelines on capital requirements and investment practices would have to be established and followed. Large banks would be accountable so firewalls are maintained.

Finally, on the subject of taxpayer exposure, Dalton raises a good point, albeit inadvertently. We should be concerned about taxpayer exposure to future bailouts. However, this is a more immediate and artificially created concern than Dalton suggests. The fact that Treasury has been sweeping up the revenues of the GSEs for three years and leaving them undercapitalized indeed raises the specter of another taxpayer-funded bailout.  For this reason, we have long argued that recapitalizing the GSEs consistent with the Housing and Economic Recovery Act should have been the first step in meaningful reform. Whatever enhanced protection of the taxpayer Dalton anticipates in a post-GSE world of similar privately-capitalized entities has been undermined by the looting of the GSEs’ capital to date. This needs to be addressed before building a new system.

All of this suggests a need for a formal review of the history of conservatorship and the future of housing finance policy by Congress. Dalton opened his commentary by insisting it is not too late to take up the fate of Fannie Mae and Freddie Mac. Indeed, Congress should make use of the new authority it conferred on itself with the enactment of the Jumpstart GSE Reform and undertake an earnest effort to reform, recapitalize and release the GSEs. That effort should start with oversight hearings on what has gone wrong with the conservatorship.

Whatever Congress decides is a better system, it must come to terms with the system that currently exists. A top-to-bottom review of the record and a flinty-eyed assessment of the realities of capital markets is needed. President Obama made it clear in his State of the Union that he is not going to push for a lot of new proposals so Congress should make the most of the coming year and not sit on its hands on housing finance.