The GSEs’ future: Part 3, choose your poison
[Continued from yesterday's Part 2 and the previous Part 1.]
After two long posts focusing on outgoing Treasury Secretary Hank Paulson’s Remarks on the Role of GSEs in Supporting the Housing Recovery, we’ve seen that the Secretary:
1. Has concluded, with audible reluctance, that privately-run GSEs are likely essential.
2. Correctly restates the inescapable dynamic tension between social and economic goals.
Tell me something I don’t already know
He offers a menu of four possible futures:
The future’s up in the air
Depending on the degree of subsidy policymakers choose, there are a variety of options for structures to replace the GSEs, including:
(1) Expanded FHA/ Ginnie Mae. Some advocate that beyond the current credit crisis the
Along with RHS, the oldest Federal housing agency, established 1934
FHA is an arm of the Federal government; Ginnie Mae is a private corporation wholly-owned by the Federal government.
Once upon a time, the peer of Fannie Mae
In either case, the GSEs would no longer have private shareholders. The size of the eligible population of homebuyers would determine how large a share of mortgage credit exposure the government would own.
I view the permanent nationalization of the GSEs, essentially expanding the role of FHA and Ginnie Mae, as a less-than optimal model.
Me too.
The blogger agrees with me?
While it offers the perceived advantage of explicit government support, it eliminates the necessary private sector evaluations of credit risk and the private market stimulus to innovation.
That’s the big defect of a purely governmental model. FHA’s last innovative product was over a decade ago, and its ability to grow its business is constantly at the whim of Congress, which doles out credit subsidy. A banker shouldn’t be politically controlled, and a banker should have financial incentive to innovate.
Next victim!
(2) Partial Guarantee. A hybrid of this would be to create a Ginnie Mae-like entity for non-FHA mortgages, structured as a partial guarantee mechanism. The new entity could operate on a similar basis as Ginnie Mae, but provide only partial guarantees for MBS. Investors would then have a floor under potential MBS losses, but would still evaluate the credit risk associated with individual issuers.
In effect, this model would make the GSEs into a last-loss insurer, taking risk greater than some negotiated levels.
That be us
The devil, of course, is in the details; if you’re taking some of the losses, then you have to negotiate how much loss you take in each issue or asset class. Pre-conservatorship Fannie Mae solved this problem very effectively with its massively successful and clever Delegated Underwriting and Servicing (DUS, rhymes with ‘muss’) program – a program, we should note, whereby Fannie Mae acquired and resold huge volumes of loan pools, without experiencing the systemic risk or balance-sheet turbocharging that got the GSEs, Fannie in particular, in their current impasse.
While such a hybrid program would clearly define the extent of the government’s guarantee, developing risk sharing parameters compatible with profit incentives would be as problematic, and potentially as inefficient, as in the current GSE structure.
The Secretary’s arguing that if the GSEs are going to have to balance the tensions between risk/ profit and subsidy/ affordability, they might as well own all of it, not just some of it, and they might as well be in the program space themselves, rather than adding a layer of principal-agent risk in working with and through independent mortgage originators, who sometimes go bad and make bad loans.
I don’t care what a blogger says, I still don’t like it
(3) Privatization. A third alternative would be to remove all direct or indirect government support, completely privatizing these companies while breaking them up to minimize systemic risk.
What we might call the AEI solution, because solons like Alex Pollack have long advocated this, and claimed it can be done at the stroke of a pen. It could, if we had an autocracy, but in a democracy, the government OODA loop of creating legislation is so slow the forces of incumbency would likely rally.
Curiously, with the conservatorship, we theoretically could completely privatize the GSEs – but we need the eggs:
As appealing as this alternative sounds, it is difficult to envision a sound, practical, private sector mortgage insurance business of any significant size that does not require large amounts of capital, and consequently generates only a modest return on capital.
“If it were privatized, it would need tons of capital that it hasn’t got.”
The recent problems encountered by monoline insurers, which ventured into guaranteeing mortgage product, as well as the experience of the GSEs, underscores this point.
Good point.
Moreover, a break up scenario does not look particularly promising, as reverse economies of scale would take hold.
Having built it, don’t unbuild it.
It is also worth noting that a regional mortgage insurer would lack diversity as a risk mitigant.
Right. Capital is national if not global.
Perhaps a consortium of banks would find it advantageous to own a national mortgage insurer to wrap their product, or some other good private sector business model may emerge.
Perhaps they wouldn’t.
Anybody out there want to own a national mortgage insurer? No?
But I am skeptical that the “break it up and privatize it” option will prove to be a robust or even viable model of any substantial scale, without some sort of government support or protection.
And I’m not the only skeptic
However, should policymakers choose to scale back public policy bias toward homeownership, we will eventually find out what business model the free market would support.
Elsewhere in this speech the Secretary makes a long philosophic discursion into the economically rational but politically incendiary territory of suggesting we should get rid of the mortgage interest deduction – but that third rail of politics is best left for another post or posts.
Wanna not get re-elected? Touch the mortgage interest deduction
Finally, in the manner of good salesmen everywhere, the Secretary finishes with the option he favors:
(4) Housing Utility. Finally, given traditional
Turning on and off the spigot of liquidity?
Under a utility model, Congress would replace Fannie Mae and Freddie Mac with one or two private sector entities. The entities would purchase and securitize mortgages with a credit guarantee backed by the federal government, and would not have investment portfolios.
These are the GSEs pre-Jim-Johnson era, with no balance-sheet turbocharging. But the Secretary wants a further shackle:
Where did those pesky GSEs go?
These entities would be privately-owned, but governed by a rate setting commission that would establish a targeted rate of return, thereby addressing the inherent conflicts between private ownership and public purpose that are unresolved in the current GSE structure.
Alternatively, the ‘rate commission’ could instead set ongoing capital requirements, and periodically require capital to be redeployed into new products. State HFA’s operate something along these lines.
This commission would also approve mortgage product and underwriting innovations to continually improve the availability of mortgage finance for a population to be defined by the Congress.
A noble ambition. Much harder than it sounds. If the rates of return are set, where’s the pressure to innovate?
In this model, continued safety and soundness regulation would be essential.
Actually, in any model they’re essential.
So Secretary Paulson plumps for a public-utility concept – which is by no means nonsensical – but just at the point the hard questions would need answering, he punts.
Next Administration!
Maybe that’s right – the decisions will belong to his successors – but it’s disappointing.
Not boldly going anywhere
In all the Secretary’s many words, there are some whose absence was deafening:
He didn’t say we needed two.
Didn’t I?
Write a comment