A few ideas:
1. Break the Mortgage GSEs into multiple smaller operating entities that focus on buying the mortgages originated for homes within a particular region. Not only will this enable them to better focus on serving the needs of a particular region, but it will also greatly reduce the risk to the economy if one of them fails.
2. Reduce the scope of the GSEs' investments to only cover mortgages that are no greater than 10% higher than the median home value of their respective region. If the government is going to subsidize housing, then its focus should be on helping average Americans of average means, not subsidizing homes that fewer than 10% of the population can afford. While a rule like this works against my own interests and gives me slight pause, I can't honestly say that buying a $450k home instead of a $600k home is a legitimate hardship. If anything a rule like this might actually depress housing prices, and in my mind keeping homes affordable is smarter public policy then enabling appreciation. The government's goal should be to enable stability and security not housing appreciation.
3. Place a cap on how large any one mortgage GSE can get. This cap could be set with respect to the larger economy and/or to the aggregate economy of the region the GSE operates in.
4. Put some realistic capitalization requirements in place. Do I really need to say more about this one when both GSEs are technically operating within the standards set forth by congress?
5. The mortgage GSEs should never be used to prop up the economy, protect against housing downturns, etc. Instead the GSEs should be managed more from the mindset of going with the flow of the economy as opposed to trying to protect it from unpleasant circumstances.
If the last 18 months or so have taught us anything, it's that it's always better to err on the side of caution when it comes to housing, and it's time that we reel in the mortgage GSEs and re-structure them so that they're smaller, more conservative and prudent organizations that aren't in a position to wreck havoc on the economy. As I said before, the current model is broken, and it's time for the government to step up, make some un-popular choices and re-position these entities in a way that allows them to continue their mission without introducing such a large degree of risk.
Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article.
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This article has 2 comments:
- UncleLongHair
- 26 Comments
Jul 16 09:40 AM1. Geographic diversity is one of the primary ways to reduce risk in investing in mortgages. This was the original impetus for FNM and FRE, as investors in wealthy parts of the country (i.e. Boston) could invest in mortgages in emerging parts of the country (i.e. Arizona). This allowed the country to grow in a stable and self-funded way and allow investors to spread risk. Later, it allowed regional banks to avoid being taken down when trouble hit their local economy, since they could sell their loans into nationwide loan pools. Restricting FNM and FRE to a certain region would be a major step backwards in risk control and add, not remove, risk from their business.
2. "I can't honestly say that buying a $450k home instead of a $600k home is a legitimate hardship." Unless there are no houses for sale in your region for less than $600k, in which case you must rent or move. FNM and FRE recently increased the conforming limits for certain counties, and some counties have a limit nearly twice the average (i.e. $730K vs. $417K). The country has a very wide range of property values, and FNM/FRE should have a presence in every market to maintain diversity (see #1). A high property value does not de facto lead to a riskier loan. If there are concerns about unsustainable home prices, they should enforce a lower LTV in those cases.
3. The OFHEO caps have been a disaster because they can't figure out a way to apply caps that adjust accurately to changes to the economy and mortgage environment. A fixed number cap does nothing but benefit the competitors of FNM and FRE, since the loans have to go somewhere, who are far less regulated and capitalized.
4. It isn't at all clear that FNM and FRE are undercapitalized. The people saying that the GSE's are undercapitalized are the short sellers who make money when the stock falls. The officials from the Fed, Treasury, FNM and FRE are unanimous in saying that the companies are adequately capitalized. Running through the actual numbers to QUANTIFY losses indicates that they are. This may change in a few quarters or years, but today the concerns are way overblown. That said, FNM and FRE could reduce their overall leverage ratio, and the $2.25 billion of emergency capital pledged to them by the government decades ago could be adjusted for inflation and growth in the mortgage market to make it a meaningful backstop instead of a token.
5. The GSE's were never intended to prop up or protect the economy. They were created to add liquidity and diveristy to the national mortgage market, which is both essential to the economy and cyclical. Without some kind of national support, regional economies would blow up again and again as local lenders accepted local deposits and lent the money locally and then had no recourse when the local economy went sour. No mortgage investor wants to invest in a basket of mortgages 100% on a California fault line or in the Florida hurricane path. Providing diversity and liquidity to the market reduces overall risk.
The main things the regulators could do to benefit FNM and FRE (and thus the national economy) would be to 1) ensure the "go-go" mentality that caused the overstated income and accounting scandal never returns, and ensure that the institutions are managed conservatively, 2) provide more transparency into the companies, it was only recently that they had to file the same financial statements as other major financial firms, 3) ensure that FNM and FRE are adequately compensated for their risk.
On that last point, FNM and FRE are basically insurance companies, accepting a "g fee" up front in exchange for guaranteeing a risk (mortgage default). If they are posting huge losses, they were not being compensated sufficiently for the risks they were taking, and many of these fees and risks were quantified by the government regulators. Warren Buffett recently noted that the government was asking (requiring?) FNM and FRE to take too much risk on their balance sheets. If they want them to thrive and survive, they need to reduce that risk.
- Jay Jay
- 61 Comments
Jul 17 11:11 PM