Near-term Ideas for Mortgage Finance Reform (Working Paper)

How to protect taxpayers, end the GSE bailout, reduce governmentís footprint in housing, and return private capital to the mortgage market

It is important, at the outset of this debate, to frame the issue properly: mortgage finance policy and affordable housing policy are two different things. Whether we should or how to subsidize low-income Americans putting a roof over their heads must not cloud the analysis and debate about the consequences of government policy distorting mortgage prices for nearly the entire housing market. Separating mortgage finance from affordable housing is important to shed light on what policy options can best be pursued to prevent another artificially-induced boom and catastrophic bust.

That being said, now is the time for major reform of the government’s role in the mortgage finance market. The housing boom and bust of the last decade is the main source of our recent economic crisis, lethargic recovery, persistent unemployment, and the massive wave of foreclosures. Yet, the past two Congresses have failed to reform America’s housing finance system.

An effective way to start a robust overhaul would be to place Fannie and Freddie into receivership, and spend three to five years winding down their mortgage business and portfolios. With the phase out of the GSEs, private capital—without government backing—could begin to move into the mortgage secondary market where it has been crowded out. Realistically, this will take time to accomplish. And in the near term there is still a need to protect taxpayers from additional, future losses while ending the ongoing bailout of the GSEs. The government’s role in housing must be reduced and private capital must be allowed to return. The following are ten ideas that will help achieve these goals.

  1. Lower all conforming loan limits for Fannie Mae and Freddie Mac by 20 percent by the end of September 2011. 
  2. Increase the down payment requirement for mortgages backed by government agencies to 20 percent over the next three years. 
  3. Instruct FHFA to begin slowly increasing the guarantee fee charged by Fannie Mae and Freddie Mac. 
  4. End all affordable housing goals. 
  5. Raise the capital requirement for Fannie Mae and Freddie Mac. 
  6. Create a legal framework for covered bonds. 
  7. Cap expansion of Fannie Mae and Freddie Mac’s portfolios at a certain date and have the Treasury Department buy their existing combined portfolio to let them run off over time. 
  8. Put the staffs of Fannie Mae and Freddie Mac on the federal pay scale. 
  9. Require the Treasury Department to formally approve new debt issuance by Fannie Mae and Freddie Mac. 
  10. Wipeout the remaining stock of Fannie Mae and Freddie Mac.

These should not be considered ways to fix the GSEs so that we can continue government support of housing finance. Nor should they be considered the only ways to address problems in the system. Very thoughtful proposals have been put forth by my colleagues at other organizations in Washington D.C. and elsewhere in the country. Rather these should be seen as interim steps that can help taxpayers and the housing sector while Congress debates how to fully reform the mortgage market. Plus, a key benefit of these ten proposals is that, while they are focused on addressing short-term needs to protect taxpayers, reduce federal bailouts, limit government’s role in the housing sector, and for private capital to return to mortgage finance, they also can be the basis for long-term reform.

This white paper breaks down these ten ideas and expounds on the framework that should guide the debate. It is a preliminary draft for public comment based on my testimony before the House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises on February 9, 2011. This will be updated after a review of the Treasury Department’s forthcoming recommendations for mortgage finance reform.

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