Fannie Mae and Freddie Mac, the government-sponsored entities – or GSEs – that were the primary source of mortgage financing during the boom of the housing market were also a major cause of the bust, according to a report the Financial Crisis Inquiry Commission released in late January.
It’s still widely agreed that they can’t go back to the status that they once had, with many calling for the government to get out of the mortgage business entirely, and others seeing a much more limited role, and only after major changes are made.
Matthew Richardson, Charles E. Simon Professor of Financial Economics Director at the Salomon Center Stern School of Business at New York University says the institutions should be shut down because they “were fundamentally flawed from the get go. A lot of people agree that the government should get out of this business and we should go to a private mortgage system. There was no market discipline.”
However, the government will probably need to stay involved somewhat during the transitional phase because it will take some time to move completely to a private mortgage system, according to Richardson. But even during the transitional phase, the private market should set pricing levels, and the government should accept that pricing model and collect premiums in return for accepting some of the risk of new mortgages – all of which should be “conforming,” meaning at least 20 percent down.
“No more 3 percent or nothing down mortgages,” Richardson says.
Richardson doesn’t see the private market being able to completely supplant Freddie and Fannie at this time, but says that any government mortgage guarantee system should run side by side with a private system, with the private system setting prices for premiums. The idea would be for the system to transition to a complete private system over the next several years.
Shari B. Olefson, author of Foreclosure Nation and attorney with Fowler White Boggs P.A., Ft. Lauderdale, Fla., agrees the government could act as a “lender of last resort” – as long as corruption and other problems were fixed.
“I’m a huge advocate of sustainable home ownership in the U.S.,” says Olefson. But corruption, lack of oversight, and other problems made the GSEs part of the housing problem rather than part of the solution to it, she says. “They were making home affordability a joke.”
Others don’t think the government should be involved any longer than it takes to transition to an entirely private system.
Government-run organizations have too many silos and two much structure. Another issue with Fannie and Freddie was that they competed with each other, raising costs for both, says Beck Walczak, who operates an operational risk management company based in Deerfield Beach, Fla.. “There’s definitely a need to have an entity for the collection, aggregation and securitization of mortgages. But not two that end up competing with each other.”
The bureaucratic organizations were slow to adopt technology and even when they did, they tended to adopt incomplete solutions, so they didn’t have the analytical capability to recognize the beginnings of trouble with many of the mortgages they guaranteed until it was too late, Walczak adds.
“Philosophically, we have to figure out if we want to support more home ownership or something else,” says Jeffrey Rogers, COO and president of Integra Realty Resources, New York. “For years we pushed for homes to be more affordable.”
That push, Rogers says, had Fannie, Freddie and lenders as a whole providing mortgages to people who realistically couldn’t pay them back. This was first felt when subprime mortgages started defaulting at higher rates than had been the norm, but extended into the highly leveraged loans provided to many of the more creditworthy borrowers as real estate prices started collapsing, followed by increasing job losses.
The government needs to get out of the business, which will result in a fundamental change in mortgages, according to Rogers. “I don’t know of any government-run entity that is self-sustaining and profitable. We should privatize what we can of it.”
But what will actually become of Freddie and Fannie? It’s too soon to say. The Obama Administration was scheduled to release a reform plan for the GSEs at the end of January, but it hasn’t come out yet.