Monday, March 29, 2010


Consider this takedown of Fannie Mae and Freddie Mac as worthwhile government activities.
Careful analysis, then, reveals the irredeemable flaws underpinning the GSEs:  their putative benefits in the provision of liquidity, and in the subsidization of fixed-rate mortgages, exist solely because they enjoy the implicit backing of taxpayers. But it is precisely that implicit taxpayer backing that destroys the integrity of their credit decision-making processes.
To correct those flaws, housing finance reform, at minimum, must abide by a handful of principles — which together mean eliminating Fannie Mae and Freddie Mac:
1. Privatize the GSEs’ credit guaranty business.  Taxpayer-supplied subsidies for homeownership cannot be effectively delivered through taxpayer-backed credit extension.  The fact of taxpayer backing destroys debt market discipline, which is a necessary ingredient for rational credit allocation. 
2. Eliminate the GSEs’ portfolio business, thereby nationalizing the emergency liquidity function.  There is no benefit provided by the GSEs’ portfolio business that is not entirely the consequence of taxpayer backing.  The portfolio business achieves that which could be provided through more direct means, but needlessly transfers economic wealth from taxpayers to GSE shareholders, GSE management, and GSE bondholders.
3. Create transparent homeownership subsidies, or none at all.  It is an appropriate time to reconsider whether homeownership is a judicious choice for lower and middle-income Americans — or at least whether it is so obviously judicious that it justifies massive taxpayer subsidization.  If, after that review, policy-makers decide to continue promoting artificially high levels of homeownership, more straightforward cash subsidies (through refundable low-income tax credits, for example) would be both simpler than GSE intermediation, and less prone to catastrophic error.
4. Create a transparent fixed-rate mortgage subsidy, or none at all.  In a similar vein, if policy-makers wish to continue to support the availability of long-term, fixed-rate mortgages, they should consider doing so directly.  For example, Congress could authorize a Fed-managed rate swap facility, which would offer subsidized fixed-to-floating interest rate swaps to banks or securitization vehicles that hold fixed-rate mortgages.  This would require that rate risk be absorbed by taxpayers, but taxpayers bear that risk today as well, given the systemic risk created by the GSEs’ interest rate risk positions.
5. Mandate standards for private-label transparency.  Due to both their dominant market share and a certain inflexibility in their IT platforms, the GSEs over time created de facto standards for the sprawling U.S. mortgage business (e.g. loan delivery standards, servicing standards) — standards that have proven alarmingly elusive in the private-label MBS market.  As the GSEs are eliminated, regulators should take care to ensure that necessary market standards are promulgated (by either private sector associations, or if necessary by regulation) in both the primary and secondary mortgage markets. [More]
While this is more than a little abstruse for most of us, it is of considerable interest to the continued existence of the Farm Credit System - another, similar GSE.

Essentially, if I grasp the point of this analysis, the same public good could be accomplished with subsidies to private lenders.These same arguments could be directed at the FCS.  More importantly, it would be hard to predict how investors would view the FCS in the wake of any major changes at Fannie and Freddie.

It will be interesting to see where those adamant about reducing the role of government in our lives come down on this free-market solution.

1 comment:

Anonymous said...

It is apparent from the recent over-expansion of ethanol plants, mega-dairies and pork conglomerates, that the Farm Credit System has used it's tax-exempt status to pick the winners and losers in today's agriculture. (The facts will show that the majority of the financing to these large entities are coming from the Farm Credit Sysytem.) In the real world it makes perfect sense that FCS would rather do one large loan than 10 smaller ones - it takes less personnel and paperwork and generates just as much revenue - until things go bad. Then, FSC can learn like Fannie, Freddie, AIG, Citibank, etc. - when you are highly leveraged (as most lenders are), it's great when things are going well and it will "suck you down faster than you can imagine" when things go bad.