The administration's white paper on housing policy is widely seen as an invitation to negotiate about what happens after Fannie Mae and Freddie Mac are wound down. While the political process will determine how much support the government will provide to the mortgage market, the question of how to provide support must be answered.
The government-sponsored enterprise was a flawed business model. Combining a government guarantee with a special charter is a recipe for losing control. The GSEs used their government backing to gain market power, and used their market power to build a formidable constituency to protect the GSEs' high leverage and freedom to take risks without being subject to a strong capable regulator.
Fannie Mae and Freddie Mac hired top officers who could handle political risks, but who were not necessarily capable of managing multitrillion-dollar financial institutions. Even before the financial crisis, the companies suffered expensive internal control failures that made them incapable of issuing accurate financial statements for several years.
We cannot afford to tie government backing to specially chartered financial companies, be they investor-owned or cooperatives or specially designed hybrids. Rather, government support for the mortgage market should come from a simple credit program that guarantees timely payment of mortgage-backed securities, similar to the Government National Mortgage Association.
The question then becomes how to involve private capital in the process. Over a dozen years ago a mortgage insurance chief executive, Greg Barmore, invented "Ginnie Mae Choice" to answer that question. Adapted to today's situation, the idea might work like this: A private company would assemble a pool of eligible mortgages and submit them to a new federal government corporation, similar to Ginnie Mae. The agency would issue a government guarantee of timely payment of principal and interest on the MBS. To obtain the government guarantee, the pool would need to be protected by a highly rated private financial guarantee, for example from a private mortgage insurance company or financial guarantee company.
The private insurer might take first loss on the pool and share risk with the government, and perhaps the loan originator, on the next losses, with the government taking catastrophic losses on the pool after that. The government and the private insurer would set standards for requiring mortgage brokers, loan originators and the securitizer to share in the risk through required participation interests, recourse and other protections.
The government and the private insurer would charge fees for their guarantees that would be rolled into the cost of the mortgage.
There are many advantages to this approach. First, the government would be teaming with a partner that would take first losses and that therefore can be expected to underwrite the pool with care. By protecting itself, the private insurer also protects the government.
Second, the government can maintain a presence in the mortgage market with its guarantee. The new program could start now, even before Fannie Mae and Freddie Mac are wound down and could help to take up the slack.
Third, this avoids the problem of trying to provide government backing to a few favored private companies; as with Ginnie Mae, any eligible mortgage pooler could obtain the government guarantee.
Finally, because the government's guarantee would be explicit, its cost would be accountable to the budget process, similar to other federal guarantees.
One question remains: What is an eligible mortgage that would qualify for government support? Here the flexibility of the idea shows itself. The political process can negotiate the extent of government support for the mortgage market by prescribing mortgage credit standards and size limits.
The new government program might be directed at first-time homebuyers and other borrowers who may need special government support.
