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It will take a recession to jumpstart GSE reform

The nation’s largest mortgage trade group, the Mortgage Bankers Association (MBA), released a detailed plan this week on how to reform the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. Mark Zandi, chief economist at Moody’s Analytics, who has co-authored a different GSE reform path, spoke with Scotsman Guide News on the prospects and path of GSE reform. Although praising the MBA’s effort, Zandi explained why he believes any GSE reform plan has less than even odds of gaining traction in this Congress.

In recent years, the GSEs have functioned quite well within the conservatorship. Why do we need GSE reform in the first place?

markzandiFirst, there is no reason why taxpayers should be making the bulk of the nation’s residential mortgage loans. There is plenty of private capital willing to take the risk and make those loans at prices that are consistent with what taxpayers are charging. It is inappropriate to be using the government’s balance sheet in this way, when the private sector is more than willing and able, and up to the task, of doing it. Second reason is that, over time, with the GSEs in conservatorship, they are going to become less able to provide affordable mortgage loans to a broad segment of the population. Those changing demographics, changing financial market conditions, changing political circumstances will be tough to keep up with, and I don’t think the GSEs in conservatorship will be able to do that. I think the availability of mortgage credit, over time, will decline, and that people who could afford mortgage loans may not get them.

What do you think about the MBA's plan to turn Fannie and Freddie into utilities and allow other chartered guarantors entry into the market?

I think it is a great effort. It does all the things that reform needs to do. It ensures that the government gets out of making mortgage loans, but provides a catastrophic backstop to the system. Their proposal ensures that a lot of private capital and plenty of protection is in front of the taxpayer. It ensures that there is access to the secondary market for lenders of all sizes and for underserved communities, and that is key to any system. Probably the best thing about their proposal — the thing that really moves the ball — was their discussion around the transition. How do we go from the current conservatorship to a future system?

There are parts of their proposal that need to be flushed out in much greater detail, such as what impact will it have on mortgage rates and availability of credit. There are some parts of it that really need to be thought about carefully in how it would work and whether it would work as well as it does in theory. The thing that immediately comes to mind is entry. They privatize Fannie and Freddie, turn them into utilities and then do a number of things to lower barriers of entry into the system of other guarantors that would compete with Fannie and Freddie. And that is exactly the right thing to do, but whether that actually works in practice, we need to think about it more carefully. Will we get the kind of entry that is necessary to make sure that they get the competition? So, I think it is a great effort, but we obviously need more granularity and that will come with time.

The MBA plan entirely depends on Congress passing legislation. Do you think that is possible within the next two years?

I would say less than even odds in the next two years because the legislative agenda is pretty full. Healthcare reform is still on the docket, then there is tax reform and, of course, there is a legislative effort to change provisions of Dodd-Frank, and lots of other issues: the debt-limit, the budget, currency manipulation. Then, of course, you are quickly into the next election season. It will be tough to get legislation through in this Congress. Having said that, reform is already happening to some degree. The GSEs are fully engaged in expanding out their credit-risk-transfers process, and that is reform that is moving credit risk from the taxpayer to the private sector. That is a key part of any reform. In the MBA proposal and other proposals, this credit-risk process is a big part of their proposal.

The move to a common platform and a single security, that also is key to any future reform proposal. The MBA [proposal] relies very heavily on a common platform and a single security to reduce barriers to entry, so you get more guarantors competing with Fannie and Freddie. That is underway. The current timeline puts completion of that in 2018. So, reform is happening. It is just not happening legislatively. But the things that are happening now are key to any successful reform proposal.

Do you think that GSE reform will get any support from Democrats? And, if so, how?

Yes, they would support it, if they felt that the future system would be able to provide access to credit to underserved communities. That the size of the credit box that exists today would be roughly preserved in the future system. There are things that can be done and should be done to ensure that progressive groups — Democrats — are comfortable with the system and its ability to provide affordable mortgage loans to credit-worthy borrowers across the credit box.

Why would it be a bad idea for the Federal Housing Finance Agency to act unilaterally to end the profit sweeps and allow the GSEs to build up small capital cushions?

Well, I don’t think they could do it unilaterally. They would have to change [the current agreement with the GSEs and the federal government], and they would need FHFA and Treasury together to agree to that change. But, let’s say FHFA and Treasury do agree, and you ended the sweep and allowed for some of the profits to go to building capital. I wouldn’t build them in the GSEs. I would build them in a mortgage insurance fund that would be separate, that would protect taxpayers regardless of what kind of system you have in the future. If you do have a system where you have a catastrophic government backstop, then you will need a mortgage insurance fund to protect taxpayers and I would use this as an opportunity to do that.

How long do you think it could take to transition into a new system if legislation is passed?

It depends on what you are transitioning to. If you transition to the government corporation that I [with other authors] proposed, that would be faster because that is how the system is evolving now. It relies on Fannie Mae and Freddie Mac doing credit risk transfer, the common platform, single security, and these institutions ultimately combining as their functions merge. That transition would be very straightforward because that is the transition we are in the middle of. We are just codifying it, and it would happen quickly — within five years.

If you go to an alternative system, say the MBA system, that is a bit more complicated and will take more time, because you need entrants. You need to facilitate entry, and it becomes more complicated because you are turning Fannie and Freddie into utilities, and that is a process. So, I think, that would take longer to do, at least five years and probably longer than that. And there are some assumptions here. We are assuming that the credit risk transfer process continues to evolve and the GSEs are able to offload more of their risk, and we are also assuming that the common platform and single security are completed by 2018, and that it works well. If those assumptions do not come to pass, then the transition process will be longer.

What are the chances that something will actually get done this time?

Legislatively, next two years, less than even odds. I think it is not likely. In the next four or six years, the odds will rise. I think the forcing action will be, in all likelihood, a recession. When you get to a recession, you will have mortgage defaults and credit losses, and Fannie Mae and Freddie Mac will start suffering real economic loss, not an accounting loss. If you get in a recession, that is economic, that is real. That could be real money and it could be for an extended period of time. It is in that environment that the pressure on lawmakers to do something will be intense from a political and, most importantly, from an economic perspective. So, that is the catalyst for substantive real change, when the GSEs are drawing on Treasury in a consistent way.


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