As Congress considers what to do with the two failed housing agencies, Fannie Mae and Freddie Mac, it is important for members of Congress to differentiate between issues of real importance to the greater public interest and those aspects of past housing policy that are either irrelevant or only of interest to special interests.

At its core, federal housing finance policy should be focused on preserving the ability of lower- and middle-income Americans — particularly first-time homebuyers — to participate in the housing market. To meet that objective, first and foremost is the question of a government guarantee for the securities issued or guaranteed by the various government-sponsored enterprises — including Fannie, Freddie, Ginnie Mae and the Federal Home Loan banks. Each of these GSEs plays a vital role in the $10 trillion market for housing finance, albeit in very different ways.

For example, the implicit government guarantee for securities issued by Fannie and Freddie is important, but the two corporate entities themselves are irrelevant to the future of housing finance. As any bond investor will confirm, the only reason that the securities issued by Fannie and Freddie have “AAA” ratings is because of the backing of the United States. Whether or not these two GSEs have “capital” is completely irrelevant to investors.

Jumbled string, straight string
Much of the focus of the GSE reform debate has been on Fannie Mae and Freddie Mac, but a system that maintains but recalibrates the government backstop can be achieved without the two mortgage giants. Adobe Stock

Calls by lawmakers in both parties to do away with Fannie and Freddie are right on target, but the government guarantee on the mortgage-backed securities they issue is vital to maintaining a homogeneous market in home mortgages. One promising idea is to eliminate Fannie and Freddie but shift their functions and liabilities to the Federal Housing Administration and Ginnie Mae.

There are a number of advantages to the Ginnie Mae market. First and foremost, the MBS bonds guaranteed by Ginnie are issued directly by the private banks and nonbank mortgage firms operating in the federally backed mortgage market. These issuers have lots of skin in the game and must closely follow the FHA’s rules regarding loan origination and loss mitigation in the event of default. Indeed, many banks have left the FHA market for precisely this reason.

While Ginnie currently guarantees the payment of principal and interest on its securities, there is no reason why the agency could not lay off some of this risk to private investors in the same way that Fannie and Freddie have successfully tested the concept of risk sharing. By paying private investors and financial institutions to take a large portion of the first-loss risk on MBS, an expanded Ginnie Mae could protect the taxpayer while providing a catastrophic backstop against severe economic downturns.

As part of a new housing finance system centered on the FHA and Ginnie Mae, the Federal Home Loan banks would also play an important role. Just like today, the home loan banks would continue to provide liquidity to member banks and nonbanks on a fully collateralized basis. The Home Loan banks could purchase housing-related collateral from members outright or help package assets into Ginnie Mae or private MBS. Meanwhile, since the Home Loan banks are an important source of liquidity for smaller banks and credit unions engaged in mortgage lending, enhancing their role could alleviate competitive concerns about larger banks gaining more market power under GSE reform.

In addition, by focusing the governmental role in housing on the FHA, Congress can clean up the patchwork of public policy goals and legal mandates that have hamstrung Fannie and Freddie, and that ultimately led to their demise as pseudo-private corporations. By narrowing the public policy focus on the FHA, Congress can encourage the growth of a truly private market in residential MBS while protecting the public interest with respect to affordable housing and credit risk.

Issuer banks and nonbanks could either seek an FHA guarantee for mortgage loans, private credit insurance or no guarantee at all. Likewise, if the issuer decided to sell MBS to investors, the expanded FHA/Ginnie market could provide a choice between government-guaranteed bonds, private guarantees or no credit enhancement. The existence of an expanded market for risk sharing on the Ginnie Mae MBS would provide real-time pricing of risk for investors and policymakers. The Ginnie platform would provide a common legal template for all of the MBS issued in this market.

Eliminating Fannie and Freddie and consolidating housing finance functions into fewer existing GSEs would, more fundamentally, simplify what has been overly complex system. Part of the reason that a private market for housing finance has not come back since the financial crisis a decade ago is that there are too many GSEs competing for market share. A number of experts have embraced the idea of a single market for government-guaranteed MBS.

“The approach to reform … that is reflected across most reform proposals, provides for a single MBS that has an explicit catastrophic backstop federal guarantee to replace the separate MBS issued by Fannie Mae and Freddie Mac that carried an ‘implied’ guarantee,” former Federal Housing Finance Agency chief Ed DeMarco said in testimony last month. “A common platform would be used to issue these securities and place the federal guarantee. Multiple private entities would be able to add loans to the common pool. This is how the Ginnie Mae securitization process works today.”

As lawmakers consider the various options for reforming the market for housing finance and winding down Fannie and Freddie, the core principle that should be followed is consolidation of the federal role down to a clear and transparent policy mandate that is focused on lower-income families and first-time homeowners. Private banks and investors are happy to make mortgage loans to higher-income Americans. Or put another way, a successful process of housing finance reform should be measured by the degree to which public subsidies for wealthy Americans are ended and private investors support a significant portion of the credit risk in the housing market.

Christopher Whalen

Christopher Whalen

Christopher Whalen is chairman of Whalen Global Advisors LLC and publishes the Institutional Risk Analyst blog.

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