Our nation's housing finance system is broken. Yes, it looks as if the housing market is slowly beginning to recover from the recession. And, yes, Fannie Mae and Freddie Mac turned a sizable profit last year. But these positive developments cannot mask the fact that far too many Americans still cannot buy or refinance a house. The solution is not to be lulled into a false sense of complacency, but rather to refashion the system to preserve access to long-term credit for working families.
Today, the federal government is effectively the sole credit allocator for housing finance, backing about 90% of new single-family loans. Private capital flows through the system, but does not absorb the credit risk associated with mortgages. Instead, the federal government bears that risk. Conservatives and liberals alike view this as both undesirable and unsustainable over the long term.
The Bipartisan Policy Center's Housing Commission recently issued a blueprint for a new system of housing finance that seeks to balance the goal of giving consumers access to stable mortgage credit, while reducing the government's dominant role and protecting the taxpayer.
The commission, whose members hail from diverse professional and political backgrounds, considered and ultimately rejected the idea of no government involvement in the new system. Given the size of the housing market, the global capital markets remain crucial to housing finance. But today the federal government acts as the only bridge to these markets. It is unrealistic to think we will dial back the clock 30 years and finance housing exclusively through bank balance sheets. The terms would be too onerous. Look at today's private-label securities market: All loans have high down payments and require pristine credit scores. Without some government involvement, widespread access to the 30-year fixed-rate mortgage would likely disappear, ending the dream of homeownership for millions of Americans.
The commission proposes to replace Fannie Mae and Freddie Mac over a five to ten year transition with a new self-supporting government entity that we call the Public Guarantor.
To ensure a smooth transition, the Public Guarantor can utilize and build upon existing technologies, market platforms and expertise.
Unlike in the current system, the Public Guarantor would provide catastrophic risk insurance only for qualified mortgage-backed securities, not for the issuers of those securities. In addition, under the new system, the government guarantee would stand behind multiple layers of private capital that would bear a predominant portion of the risk. Envision a domino of loss-absorbers. First would be the borrowers and their home equity; homeowners would swallow the initial loss. The private credit enhancers come next, ranging from capital market products to highly capitalized mortgage insurers. These credit enhancers help borrowers with insufficient down payments, and they too would take their losses. Third, the corporate resources of the issuers and servicers would step up to assume some losses. The federal government comes last, which would absorb only the catastrophic risk; for example if home values plummet more than 35%. By putting the government in the "fourth loss" position, taxpayers are protected, while opening the door for the re-emergence of private capital.
The Public Guarantor would have significant standard-setting responsibilities in this new system. The president would appoint its director, subject to confirmation by the Senate. An Advisory Council composed of the chairman of the Federal Reserve, the Treasury Secretary and the Secretary of Housing and Urban Development would advise the Public Guarantor regularly on important marketplace developments.
For the Federal Housing Administration, the commission envisions a more targeted, smaller role, focusing on first-time homebuyers without substantial down payments and with less-than-pristine credit scores. FHA would lower loan limits for FHA-insured loans, basing them on house prices in metropolitan areas.
For most prospective homeowners, the new system's impact on mortgage affordability would be minimal. The introduction of more private, risk-bearing capital to housing finance should expand homeownership possibilities. The status quo – where the taxpayers ultimately bear the risk and capital markets reap the profits – is both unfair and untenable. It is time to design a new architecture for this new economic reality and begin the transition.
Nicolas P. Retsinas and Rob Couch are members of the Bipartisan Policy Center's Housing Commission. Retsinas served as FHA Commissioner in the Clinton Administration and Couch, of counsel to Bradley Arant Boult Cummings LLP, served as Ginnie Mae President in the George W. Bush Administration.