How to Get the Government Out of Mortgage Lending
Let’s not repeat 2008.
One of the least discussed challenges of the incoming Trump administration may also be among the most economically consequential: what to do with Fannie Mae and Freddie Mac, the government-controlled entities that own or guarantee about half of all U.S. home mortgages.
Trump's pick for Treasury Secretary, Steven Mnuchin, has said he wants to put housing finance back into private hands. Sensible as the goal may be, the hard part will be getting there.
Fannie and Freddie illustrate how slippery the term "private" can be. The two operated as privately owned corporations for decades, albeit with a congressional mandate to promote access to mortgage credit. They generated ample profits for shareholders and gained a dominant position thanks in large part to the expectation that the government would rescue them in an emergency. That perception proved correct in 2008, and they have been wards of the state ever since.
The failure of Fannie and Freddie has drawn the government far deeper into U.S. housing finance than it ever intended, at a time when even its pre-crisis involvement appears excessive. Subsidized lending may have boosted home ownership, but it also contributed to a consumer-debt burden that has hobbled the recovery and rendered the economy more prone to crisis. Most other advanced-nation governments play a much smaller role, with little apparent effect on home ownership.
So how can the government extract itself? It can’t happen overnight. Mortgages as Americans know them -- with 30-year fixed interest rates, no penalty for early repayment, and the ability to lock in a rate before buying a home -- all depend on Fannie and Freddie's willingness to buy loans from banks, package them into standardized securities, and guarantee payments of interest and principal.
To their credit, Fannie and Freddie have taken a significant step forward: In the past few years, they have been selling a new kind of security that transfers risk to private investors. (Buyers of such securities get a smaller return if a reference pool of mortgage loans incurs losses.) Under one reorganization plan, this risk-transfer program could be used to help attract enough private capital to cover at least a 6 percent loss on guaranteed mortgages -- more than enough to weather a crisis like 2008. With ample capital protecting taxpayers, the government could then charge a small fee for taking on the bit of risk that no private institution can credibly bear: Providing a backstop in a truly catastrophic crisis.
Such a system would have many advantages. Perhaps most important, it would align the price of guarantees with the cost of private capital. This would give other, more completely private lending channels -- such as banks making loans to keep on their own books, or to package into securities without guarantees -- a greater opportunity to regain market share (a goal that will also require other measures, including regulatory relief for community banks). The guarantor would still be a public entity, but the result would be a much smaller government footprint, and new competition to engender better alternatives to the traditional 30-year mortgage.
An abrupt or poorly designed reform, by contrast, could discredit the very idea of privatization. If, for example, the government simply transferred Fannie and Freddie's business to undercapitalized banks, the outcome would be all too familiar: Private shareholders would reap the gains in good times, and taxpayers would be on the hook when the losses subsequently materialized.
That's one bit of history that Trump and Mnuchin should be striving not to repeat.
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