Addressing the home mortgage meltdown, Congressman Scott Garrett recently introduced legislation that is, as American Banker put it, "designed to draw the private sector back to the secondary-mortgage market after the troubled GSEs are terminated."
Community bankers should be wary of legislation that would eliminate a program that for over 70 years has provided a ready market for responsible home ownership. Congress first introduced the GSEs in 1916 with the creation of the Farm Credit System and legislated GSEs for home financing in 1932 when the Federal Home Loan Banks were initiated.
During my 22 years as a president and CEO of a community bank, it was axiomatic that the bank's success was enhanced by the availability of the Fannie and Freddie secondary market for mortgage loans. In fact, the bank's home mortgage portfolio and concurrent service to the community were virtually doubled by selling loans in compliance with the strict underwriting standards and implicit guarantee provided by the GSEs. They have provided a significant public service by making home ownership a reality for millions of Americans.
At the start of the "credit bubble," the private sector finance companies including Countrywide, Washington Mutual and Citigroup, changed the dynamics of the secondary mortgage market. To generate volume, they attempted to undercut the GSEs by ignoring conventional credit underwriting standards. Perceived asset values, supported by "mark-to-market" accounting standards replaced repayment criteria and, in addition to buying mortgage paper from existing financial institutions, mortgage originators were commissioned who needed no lending credentials other than the ability to prepare loan application forms.
Community bankers recoiled at this development along with new mortgage credit jargon such as "low doc" and "liar's loans." These activities were particularly troublesome since the new wave originators, without capital or subject to recourse, were given financial incentives to generate loans — no matter the qualifications of the home buyers.
At the micro level, community bankers who resisted the temptation to match this bogus lending model were not significantly affected by the rogue lenders. If the GSEs had followed that example they might have obviated the need for government seizure and subsequent bailout. Instead, GSE governance attempted to match the finance company paradigm by abandoning proven underwriting standards and granting large executive bonuses to executives.
Now we face the specter of politicians and others calling for either the abolishment or total reform of the GSEs. Congressman Garrett, in introducing his new bill, apparently wants the same private sector that pumped air into the housing bubble to reemerge as the primary source of secondary-mortgage financing. Yes, the GSEs were complicit in the credit crisis, but the concept and continuation of a dependable and affordable government-sponsored market for qualified mortgage lending still presents a great opportunity for community bankers and home buyers. Depending on "too big to fathom" competitors would seem to be a shortsighted solution.
Robert F. Muth is a vice president and principal of Banklogic and the former president and CEO of Andover Bank in Andover Ohio.