GSEs, Private Mortgage Market Need Each Other

It's been five years since the mortgage meltdown. Mistakes were made and expectations were lowered. It's now time we look back in retrospect, analyze what worked and refine it based on what  we've learned during the past five years. The secondary mortgage market is still struggling to rebound and the question of how to handle the government-sponsored enterprises, Fannie Mae and Freddie Mac, persists.  

The answer, however, may be simple. It's time to head back to the future.

Despite the grandstanding from some politicians, Fannie Mae and Freddie Mac are not going away entirely. More important, they shouldn't go away. For almost 50 years prior to the meltdown in 2007, Fannie and Freddie were private entities traded on Wall Street. Both facilitated capital into the mortgage lending market and they were excellent at it. However, things got a little sideways when both GSEs started participating in riskier lending that was outside their original charter.

We all know the story of how Fannie and Freddie ended up where they are today: private entities, meltdown, conservatorship, government bailout. They unfortunately experienced bad loans and now they've taken their losses. It really isn't any different than a regular business going through bankruptcy procedures.

Now, both GSEs are experiencing record profits – Fannie at $58.7 billion and Freddie at $4.6 billion in the first quarter of the year – paving the way for their reform. The GSEs' guarantee fees are significantly higher than they were just a few years ago, while they have both taken on minimal-to-zero additional risk – explaining their record profit numbers.

Of course, Fannie and Freddie reform will face opposition. The reforms that are crucial for ongoing recovery and stabilization would require Congress to diminish their involvement in the lending business and allow the GSEs to do what they do best: act as a conduit for private capital to enter the residential lending market.

So, what does the secondary market need then?

The secondary market needs the GSEs to play the role it used to play so well: producing conventional, high quality loans, while issuing high quality securities from those loans. How will past successes of the GSEs and lessons learned from the current government conservatorship marry to modify the roles they play now?

According to the Department of Commerce‘s census statistics, U.S. homeownership in the first quarter of the year hovered around 65%. Americans are opting out of the "American dream" of purchasing and owning a house and choosing to rent or lease instead. In 2000, according to the same source, homeownership sat comfortably at 67.1%. This statistical drop may not be dramatic to some, but our nation has been and will always be one where real estate ownership is plausible for everyone; an opportunity that attracts people to move to America in the first place. The market should always see incremental improvements in homeownership – it's a consistent indicator of a healthy economy.

Private investors have their own particular underwriting guidelines, as do Fannie and Freddie. The Consumer Financial Protection Bureau's lengthy qualified mortgage rule also provides the blueprint for the standards the GSEs will require in the future. Under current Fannie stipulations, a borrower must be employed by the same employer for at least two years.  In our fluctuating market, borrowers with new jobs will find themselves out of luck if they wish to close on a Fannie loan, even if they have impeccable credit history.

By allowing Fannie and Freddie to share risk with private investors, credit enhancements such as mortgage insurance would extend credit to borrowers who are creditworthy but currently cannot attain it due to strict underwriting guidelines. This would all happen while minimizing the risk to taxpayers. It would also increase competition, drive down lending expenses, place more borrowers in the market and fuel the housing recovery.

The mortgage reform process will be no easy feat. The secondary market reform begins with bringing private capital back into the mortgage market and minimizing the taxpayer burden for the GSEs.  Underwriting standards can then be modified to extend credit to more borrowers. Policymakers need to assure standards are tight enough to ensure the borrower's ability to repay, yet flexible enough for borrowers with various financial states to qualify. The current conservative underwriting guidelines bar large segments of the borrower market, hindering people from obtaining credit and purchasing a house.

Fannie and Freddie own or guarantee about half of all U.S. mortgages worth almost $5 trillion, effectively rendering them a monopoly due to their government conservatorship status. This power allows them to unfairly raise guarantee fees and cherry-pick credit from borrowers, resulting in profit windfalls for them and restricting credit availability for creditworthy citizens. By allowing private capital to invest and share the GSEs' risks, capital would be more available to the market, creating more buyers and assisting in the housing industry's recovery.

Scott K. Stucky is chief operating officer of DocuTech Corp., a provider of mortgage loan documents, compliance services and technology solutions for the mortgage industry.