Free Market Reform for Fannie and Freddie

Today, the Treasury Department is hosting a conference on reforming Fannie Mae and Freddie Mac. They were basically ignored by the recent Wall Street reform Dodd-Frank Act, but now Secretary Geithner is ready to get down to business. As I see it, there are two central debates that are framing this discussion:

  1. Does the government have a role in housing finance reform?
  2. Should the expansion of home ownership be a policy goal of the government?

The answers to these two questions fundamentally direct the way one thinks about reform. In my view, the answer to both is “no”. The more government is involved in housing finance, the more distorted the market gets. New York Times finance journalist and editor of DealBook Andrew Ross Sorkin this morning cited my letter to Secreatry Geithner making this point:

“Were the G.S.E.’s to cease buying mortgages or guaranteeing mortgage-backed securities, financing for buying homes today would be virtually nonexistent until the banks got back up on their feet. This would result in mortgage prices increasing, causing demand for housing to decrease, taking the value of homes even further down,” Anthony Randazzo, director of economic research of the Reason Foundation, wrote in a letter to Mr. Geithner.

Nonetheless, Mr. Randazzo, whose foundation leans toward libertarian views, takes a much bolder step. “This means that prices have not been allowed to reach their natural bottom, from which a sustainable recovery could begin.” And Mr. Randazzo wants to see housing prices truly bottom out.

But allowing the housing market to collapse simply so it can rise again — a very free-market approach — is politically unpalatable…

To clarify here, I do want to see prices bottom out, but there is a difference between prices bottoming out and the market collapsing. I point out in my letter that we should be prudent about the reform process, taking apart the GSEs over time to avoid a market shock. But prices are too high. If we build a recovery on artificial housing prices then we will just have to deal with more problems in the future. We do need to end the GSEs without replacing them. And we need stable housing recovery, no matter how politically unpalatable.

And when it comes to the policy goal of home ownership—with the corellary that the government should try keep mortgage rates low—Washington must understand how this aim contributed to the distortions in the market leading to the bubble. We can’t just assume that low mortgage rates are a good thing. That artifically boosts housing prices and is the definition of a pro-cyclical policy.

Click here to see my letter to Secretary Geithner.