Time to Settle for GSE Restructuring?

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Let's face it: Thanks to the politics associated with reform of the government-sponsored enterprises since Fannie Mae and Freddie Mac entered conservatorship in 2008, major structural change in the secondary mortgage market is unlikely to occur anytime soon.  

The latest attempt, introduced by Sens. Tim Johnson, D-S.D., and Mike Crapo, R-Idaho, seems destined for the same fate as other bills. Early buzz for bipartisan support has fizzled out due to an inability to attract broad-based consensus. Yet mortgages muddle along in a zombie secondary market: not fully dead, not fully alive. Maybe we're all trying too hard at putting together lasting reform. Perhaps the answer is a far less expansive effort that brings some resolution to mortgage markets. Could it be that major changes in the way the GSEs and their regulator operate today already clear the way for getting secondary markets back on track?

The same political stalemate that has brought us to the brink of a debt ceiling crisis, government shutdowns and other unpleasantness has descended upon GSE reform over the last five years. Republicans appear unlikely to acknowledge that anything other than a largely privately capitalized mortgage market can work effectively while protecting taxpayers from future mortgage crises. And Democrats seem equally unwilling to accept that housing policy and politics in the form of heavy affordable housing goals don't mix well over the long term.

And therein is the problem: viable market solutions exist and have been proposed time and time again by leading experts only to be rebuffed by political forces that are clearly out of their element when it comes to solving complex capital markets problems.

In the absence of a willingness and capacity to find common ground in attaining meaningful reform, maybe the easiest path – though clearly a second-best outcome – is to restructure the existing GSEs and reboot the secondary market. The GSEs deserve our enmity for abetting risky practices that brought on the mortgage crisis. However, if we step back from the outcome and consider what aspects of their charter facilitated their demise, we find that most of the problem has already been addressed.

The seven deadly sins of the GSEs in no particular order of impact were: abnormally low capital requirements; shamefully weak regulatory oversight; an implicit guarantee by the U.S. government; retained portfolios with an insatiable appetite for assets that fueled excessive risk-taking; a distinctively large lender bias that placed small firms at a competitive disadvantage; a schizophrenic mission seeking to maximize shareholder value and political franchise value at the same time; and heavy congressional meddling that introduced enormous political distortions in the form of excessive affordable housing targets into the secondary market.

Most of these items and more have been addressed in one form or another since the crisis. Others could easily be addressed with far less effort than radical overhaul of the secondary market.

For example, regardless of the purpose, the qualified mortgage rule has brought a measure of sanity to mortgage credit policy, despite the fact that the federal government now is in the business of establishing credit standards. And, with both retained portfolios of the GSEs being wound down, opportunities for excessive risk-taking at taxpayer expense seems remote. GSE capital requirements could be raised consistent with Basel III-compliant banks as a condition for recapitalization, reducing the chances for insolvency in the future of either entity. Regulatory oversight since the crisis has significantly improved since the days of the Office of Federal Housing Enterprise Oversight with the creation of the Federal Housing Finance Agency. And small lenders today have more direct access to the agencies than before.

These changes, coming at a time of ongoing profitability at the agencies, would greatly limit the formation of another massive housing bubble. It reduces any sense of urgency to change the status quo. Political stalemate on what to do with Fannie and Freddie appears to be a perennial topic for would-be market reform, but the reality is that politics has held hostage the best opportunity we have for long-term sustainable housing finance reform. Perhaps the time has come for a dose of reality that restructuring the GSEs might be the only viable path to revitalizing housing finance in this country. A mediocre solution as unappetizing as that may be, in the long run, it is preferable to no solution at all.

Clifford Rossi is the Professor-of-the-Practice at the Robert H. Smith School of Business at the University of Maryland and a principal in Chesapeake Risk Advisors LLC.

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