Put Your Money Where Your Mouth Is

George Yacik - INO.com Contributor - Fed & Interest Rates

Last week Federal Reserve Governor Jerome Powell joined the chorus of prominent industry leaders and government officials calling for reform of the American housing finance system, namely by reducing the government’s role in the business and bringing in more private capital.

Some questioned why Powell should speak on this subject, given that – as he told his American Enterprise Institute audience –the Fed “is not charged with designing or evaluating proposals for housing finance reform.” Still, he pointed out, “we are responsible for regulating and supervising banking institutions to ensure their safety and soundness, and more broadly for the stability of the financial system.” Besides, he noted, he was expressing his own personal views on the subject, not necessarily the Feds.

But what caught the attention of a lot of people, including myself, was the sense of urgency for reform that Powell claimed existed.

“What really provoked me to come forward is this feeling that we are almost in a now or never moment here,” he said in a question-and-answer session after the speech. “It is not a current risk. The economy is healthy; the housing system is healthy. But if we don’t get off of this we will find ourselves I believe over time back in a bad place with a lot of exposure to the taxpayer and financial instability issues.”

To my reading, Powell didn’t suggest anything new, repeating what others before him have said, namely that it’s imperative to get the private secondary mortgage finance system functioning again. But he didn’t address the question, that I could see, namely exactly what is preventing the creation of a private mortgage-backed securities market.

As Powell pointed out, “after reaching nearly 30% of the market before the crisis, private-label securitization has dwindled to almost nothing today.” But what’s stopping it? Why exactly does the government need to step in and create a private market for mortgage-backed securities? Why can’t the great minds of Wall Street create their own market?

As I pointed out in a recent column, the U.S. mortgage market has been operating just fine since the government took over Fannie Mae and Freddie Mac after they failed during the global financial crisis in 2008. Mortgage credit quality has significantly improved, and as a result, the two government-sponsored entities have now not only returned all of the $188 billion that taxpayers spent to bail out the two agencies but have earned nearly $266 billion, most of which has been returned to the U.S. Treasury. Here, you might say, is a government program that not only works but pays for itself – and then some.

Many people see another crisis brewing if we don’t come up with a permanent solution to “fix” Fannie and Freddie, without explaining exactly why they need to be fixed. What I suspect they mean is that they want a piece of that $266 billion, and they want the government to bear most of the risk while they take most of the profits, just like before Fannie and Freddie went bust.

There is certainly a need for private money in the mortgage market. As noted above, the market has been operating pretty well since the government placed Fannie and Freddie in conservatorship. That doesn’t mean it can’t do better, but it will likely take private money to do that. As Powell said, “The status quo may feel comfortable today, but it is also unsustainable.”

One of the shortcomings of having the two GSEs as wards of the state is that mortgage credit is restrictive – and rightly so. To protect taxpayers from another failure and bailout, the two agencies have mostly limited the loans they agreed to purchase to borrowers with excellent credit. Nothing wrong with that. The problem is that lots of people who don’t have perfect credit can’t get a loan, certainly not as easily as they could in the run-up to the financial crisis.

But that’s where the private market could step in. Yield-starved investors, you would think, would be happy to make loans secured by residential real estate at say, 6% or 7%, a significant yield premium over what Fannie and Freddie charge. Why can’t the Wall Street investment banks or the big mortgage lenders like Wells Fargo and Bank of America, on their own, step in and create a market to meet this demand, both from borrowers and investors?

The stumbling block is that some people want to have it both ways – a for-profit mortgage market backed by the full faith and credit of the American taxpayer, just like in the old days. We already know that won’t work. Fannie and Freddie should remain public utilities, while a private market handles everything else. There should be plenty of business to go around for everyone.

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George Yacik
INO.com Contributor - Fed & Interest Rates

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.

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