“Moving beyond Freddie and Fannie”

Washington Post: Moving beyond Freddie and Fannie
By Bob Corker
November 25, 2011

The term "permanent conservatorship" is an oxymoron. By its very construct, the conservatorship of a corporation is meant to be temporary. And yet three years after the bailout of Fannie Mae and Freddie Mac, we are no closer to transitioning them off government life support than we were the day in 2008 when they came under direct government control.
This is unacceptable.
A delay in dealing with Fannie and Freddie was partly inevitable, as policymakers worried that any misstep could negatively affect a fragile housing market. But we have come to a point where continued inaction impedes the ability of the private market to take over a function the government has completely mismanaged. We must move beyond Fannie and Freddie, immediately.
This task will not be politically easy. Many of the institutions that have come to rely on the corporate welfare Fannie and Freddie provide have argued that we cannot have a housing finance system without the support of government-sponsored enterprises (GSEs). This argument not only ignores the risks taxpayers are forced to bear but also fundamentally misrepresents the structure of the housing finance system.
Broadly speaking, the risks inherent in mortgage lending can be placed in two categories, interest rate risk and credit risk. Interest rate risk stems from the fact that homeowners can prepay their mortgages at any time, and they generally choose to do so when interest rates are low. This leaves the lender with the tricky job of managing an asset-liability mismatch. But the private sector has proved capable of the task. In fact, the development of the risk management infrastructure to deal with this challenge remains a great accomplishment of modern finance.
The second risk in mortgage lending is credit risk, or the risk that a borrower will default on his or her mortgage. Today, mortgage credit risk is almost completely priced and managed by the government. Having "crowded out" private investors by charging an insurance premium that was too cheap, the GSEs are saddled with $5 trillion worth of bad credit. This is a tragedy of our own making. During the boom years, the GSEs' affordable housing goals were coupled with a Congress and an administration that saw only the bright side of rapidly increasing homeownership rates. That meant that as housing prices began to spike, it was impossible to make credit slightly more expensive. Without countercyclical market mechanisms able to operate naturally, as housing prices went higher, the GSEs simply raced each other to lower guarantee fees, out of fear that they might lose business from mortgage originators such as Countrywide and Washington Mutual. The result, we now know, was a government-induced bubble followed by a painful collapse.
This month I introduced legislation that can help bring private capital back into this market in an orderly fashion. The Residential Mortgage Market Privatization and Standardization Act would reduce the federal government's exposure to GSEs by 10 percent per year for 10 years. It will do this by gradually diminishing the percentage of an agency mortgage-backed security that is backstopped by the taxpayer. This methodical process will allow for clear market signals, so everyone can easily see where the market and the government each price credit risk. Additionally, the bill includes some basic infrastructure improvements, such as creating uniform servicing agreements, putting in place some minimum underwriting standards - such as a 5 percent minimum down payment and requiring that loans be fully documented - and making available for public consumption the large amount of data sitting in the vaults at Fannie and Freddie. Such initiatives would put us on a path toward a sustainable housing finance system for the long run.
Ultimately, the market will price mortgage credit risk much more efficiently than does the government. We should not be deterred by red-herring arguments to the contrary. Fannie Mae and Freddie Mac are costing taxpayers billions of dollars every year. We must begin the process of unwinding the GSEs. "Permanent conservatorship" is not a credible plan.