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If President Trump is Looking for a Policy Win, Try GSE Reform
This piece represents the opinion of Zillow Group Chief Analytics Officer and Chief Economist Dr. Stan Humphries.
While
the political calculus in D.C. seems to be changing daily, two things
seem to be true as of this week: President Trump is eager to notch a
successful legislative victory and his displeasure with the House Freedom Caucus’s role in the Republicans’ failure to repeal Obamacare might be making him more willing to work with Democrats to achieve legislative success.
I’ve got a shovel-ready project that achieves both of these goals: Fix Fannie Mae and Freddie Mac, the two mortgage giants (so-called government-sponsored enterprises, GSEs) that the government took over in 2008 in the midst of the housing market collapse.
Why GSE reform? It’s a critical, if under-appreciated, issue affecting most Americans and there’s already abundant bipartisan agreement on the basic outlines already.
Fannie and Freddie are involved in about half of all mortgage originations in this country (the rest are backed by banks and other government agencies like the Federal Housing Administration and the Department of Veterans Affairs). GSEs provide a public guarantee on mortgages that is essential to creating confidence among investors who purchase securities backed by those mortgages. That process takes the money found in investment and pension funds and makes it available to individual homebuyers. The GSE guarantee keeps mortgage rates much lower and helps to keep the 30-year fixed-rate mortgage within reach of millions of American households.
The problem is that the temporary fix left the two GSEs with no capital reserves, a revenue stream dependent on a fee set by a political process, and an open checkbook from the U.S. Treasury in the event of any financial losses.
You don’t have to be Warren Buffet to see a few flaws in the current setup. As even a casual student of economic history over the past decade knows, the housing market is prone to cycles. A slowdown in home purchases (which reduces GSE income because they collect fewer fees) and a decline in home prices (which increases GSE expenses due to foreclosures and less interest on their assets) would lead to some big draws on taxpayers’ wallets.
The good news is, there is no shortage of detailed proposals to fix this problem (see here, here, here, here and here), and most of them have broad bipartisan support for a common set of elements. First, an explicit public guarantee for a safe class of mortgages, and second, a new, simplified entity that securitizes mortgages and replaces most of the functions of Fannie and Freddie.
The proposals differ in terms of whether this entity should be a government agency or a government corporation. But either way, recent history suggests we shouldn’t return to the old model of Fannie and Freddie, where private stakeholders benefit from an effective government-sanctioned duopoly and there’s little real competition on the securitization function itself. Absent a competitive dynamic, the business takes on the dynamics of a public utility, like electricity, so we should structure it as such.
Third, the fees charged for the public guarantee should be commensurate with the actual credit risk, not politics. For example, in the final weeks of the Obama administration, the insurance fee charged to borrowers by the Federal Housing Administration was lowered (and subsequently reversed by the Trump administration). One of the arguments for lowering the fee was that doing so would help offset the higher costs borne by borrowers due to recent increases in mortgage rates. This is a fundamental error which, in some part, was seen in the last housing cycle with Fannie and Freddie under-pricing their guarantee relative to the actual risk they were incurring. The result was that their reserves were inadequate to withstand the severe downturn that occurred. The function of mortgage insurance is not to create a constant level of affordability for housing but rather to compensate a lender in the event that the borrower defaults. It should be priced accordingly.
What makes GSE reform an ideal next item on the President’s agenda is that these various reform proposals have already been baked into legislation that achieved bipartisan support by the Senate Banking Committee. While that effort died in the waning days of the Obama administration due to a combination of election priorities and some dissention within the ranks of Democrats, it suggests that a bipartisan coalition of centrist Republicans and Democrats does exist to pass reform.
Moreover, the political optics of the issue are favorable to the President: He’d be able to end the temporary government ownership of two private sector firms (Fannie and Freddie), address a bread-basket concern for Americans (ensuring affordable home mortgages), and overcome eight years of endless talk inside the Beltway that has produced no results. All while notching the first item on a list of accomplishments and burnishing his reputation as a pragmatic dealmaker across party lines.
If the Trump White House is smarting from their attempt to wrangle health care to sanity, GSE reform could be a great candidate for an easy win that is important to consumers.
