A steady Freddie?

Sunday, June 6, 2010

BY NOW IT'S CLEAR that whatever Congress does about financial reform this year almost certainly will not include a permanent fix for Fannie Mae and Freddie Mac, the two mortgage giants currently hemorrhaging taxpayer cash. But new ideas are percolating in the private sector, academia and think tanks.

A recent example is the proposal by two moderate Republican economists, Donald Marron and Philip Swagel, which notably departs from their party's free-market orthodoxy while promising to abolish the most toxic features of the old "government-sponsored enterprise" model. In particular, the plan would get Fannie and Freddie out of the business of directly purchasing mortgage-backed securities, which was highly profitable to them in large part because their implicit government guarantee enabled them to fund a large portfolio at artificially low rates. Their existing $5 trillion pile of securities and guarantees would be wound down or sold off to the private sector.

But Mr. Marron and Mr. Swagel would keep a government role in Fannie and Freddie's other business: securitizing conventional, moderately sized "conforming loans," which is both necessary to mortgage liquidity and relatively less risky. And instead of a non-transparent, implicit government guarantee, the new securities would carry an explicit one, for which the securitizers would pay a fee. Accumulated fees, in turn, would cover losses, thus shielding taxpayers. To promote innovation and competition, this business would be open not only to Fannie and Freddie but to any other well-capitalized financial institution capable of taking it on.

Crucially, there would be no mandates to support affordable housing of the kind that Congress routinely imposed on Fannie and Freddie. Though appealing in theory, these "goals" proved irresponsible in practice. The companies met them by stuffing their portfolios with risky loans to marginal borrowers, who defaulted by the thousands when the downturn hit. That's not to say government has to get out of promoting low-income housing completely. But it is far better, as Mr. Marron and Mr. Swagel suggest, to address such policy goals directly, through agencies designed for that purpose, such as the Federal Housing Administration.

Mission creep and public-private confusion destroyed the mortgage system. Clarity and consistency can restore it.


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