Another Proposal on GSE Reform

Free market defenders Peter Wallison, Alex Pollock, and Ed Pinto have released a joint white paper offering a series of changes to reform the housing finance system. The proposal this morning is built on four principles for building a solid foundation for US housing finance:

  1. The housing finance market—like other US industries and housing finance systems in most other developed countries—can and should principally function without any direct government financial support.
  2. To the extent that regulation is necessary, it should be focused on ensuring mortgage credit quality.
  3. All programs for assisting low-income families to become home-owners should be on-budget and should limit risks to both homeowners and taxpayers
  4. Fannie Mae and Freddie Mac should be eliminated as government-sponsored enterprises (GSEs) over time.

The inability of Congress to take up a reform effort for Fannie and Freddie over the past two years is one of the most glaring failures in Washington. The GSEs were at the center of of the financial crisis and recession, yet have gone virtually unchanged since being taken into government conservatorship in mid-2008.

The GOP in the House has pledged to take up GSE reform early in the Congressional year, though it is unclear what priority the Senate is giving a fix for the housing finance system. But as most economic outlooks for 2011 indicate, a bad housing market is going to be the biggest drag on GDP growth in the coming year. It is imperative that the mess is cleaned up, Fannie and Freddie wiped out, the FHA standards reformed, and a new system for financing homes ushered in—and soon.

This paper offers a quality vision for what the housing finance system should look like in a reform environment. While those seeking a market-oriented solution may disagree with some of the details in the report, the most important aspect of this proposal is that there is no government guarantee for mortgages and Fannie and Freddie would go away. There are a number of things that can be done to encourage private capital to fully fund the mortgage and secondary mortgage markets, but the most critical thing is to end the cycle of government subsidies that have distorted the housing market for the past 80 years.

A change like this is going to require a rethinking of homeownership, which I wrote about last October in this paper.

Read the whole AEI report here.