Earlier this month, President Obama renewed his call to replace Fannie Mae and Freddie Mac with private sector solutions, so that taxpayers would never again be forced to bailout the mismanagement of these gargantuan quasi-government entities.
A bipartisan proposal from the Senate has been served up to gradually build private sector financing markets that would somehow keep the federal government in the equation as the ultimate-worst-case-scenario backstop if needed. A more aggressive proposal from the House would simply phase out government involvement altogether and create a new secondary market space for private investment competition.
Our leadership is proposing the creation of a brave new uncharted mortgage finance world to be pioneered by the folks that brought us to the brink of financial Armageddon in 2007. Financial scholars like these ideas, citing increased competition and innovation resulting in new and improved product offerings. These proposals assume that replacing the draconian and dominant 30-year fixed rate mortgage with financing alternatives that better fit the needs of individual borrowers will create a more stable lending environment.
I do not have the credentials of a financial scholar and I am not an elected leader, but apparently I have a better memory. Profit driven competition and innovation in the mortgage industry, and the proliferation of financing alternatives to better fit individual borrowers, gave us the no employment, no income, no asset, no down payment, weak credit history mortgage financing collapse that we are still recovering from. How can anyone propose that we frame a landscape that leaves open a door to the kind of runaway risk that crippled Fannie Mae and Freddie Mac the last time we tried it?
Fannie and Freddie are popularly portrayed as the villains that perpetrated the mortgage meltdown, when in fact they were simply the playing field. With investment banks in the skilled positions, lenders on the line and our political leaders coaching from the sidelines, private sector competition and innovation in the mortgage industry is the villain that led to the collapse. Remember, Fannie and Freddie purchase and securitize mortgage loans from banks and mortgage lenders, essentially creating the secondary market space for Mortgage Backed Securities (MBS). As the sellers of these loans, the banks and mortgage lenders are responsible for the quality of the loans they are selling. It was the sub-standard quality of the loans originated and underwritten by the banks and mortgage lenders that resulted in widespread defaults and caused the catastrophic losses at Fannie Mae and Freddie Mac.
Our political leadership is proposing that we abolish Fannie and Freddie for the sins of the banks and the mortgage lenders, and then hand over the keys to these same architects of the mortgage disaster that brought us to the brink of financial collapse. We are still healing and these are serious people proposing that we again legislate our way to mortgage prosperity, using no more common sense than that which got us into this mess. What could go wrong?
Mortgage underwriting guidelines, limits, parameters, do’s and don’ts, time frames, fouls, requirements, all rules promulgated to create a uniform baseline for constructing quality loan files are vetted and published in Fannie Mae and Freddie Mac Selling Guides. These are the mortgage bibles from which all mortgage lending originates, private lending sources refer to these Selling Guides when constructing their own private lending guidelines, tweaking as their individual markets dictate. Eliminating Fannie and Freddie will erase the home base source from which mortgage rules come from, leaving market forces to determine what is necessary and what is not.
The sheer size of these two government sponsored institutions validates the statistical populations from which mortgage underwriting guidelines are created. Delegating this function to individual private lending institutions, however big they may be, creates a fertile breeding ground for evolutionary risk/return mortgage lending that is absent boundaries but with a government bailout safety net.
The existence of Fannie Mae and Freddie Mac provides accountability and recourse for policing lenders that cut corners and sell low quality default risk loans. Today, post-mortgage meltdown, a lender can be forced to buy back a loan that is below guideline or document credit quality even if it is not in default. Without Fannie and Freddie, lenders will be guided by the Consumer Financial Protection Bureau (CFPB) and the feeble Ability-to-Repay Rule (seeThe Great And Powerful New Ability-To-Repay Rule), or better yet, be left to police themselves.
The automakers, Wall Street investment banks, gargantuan global insurance companies, all received government bailout money and nobody on either side of the aisle is proposing that any of these entities be dissolved. The proposed replacing of Fannie Mae and Freddie Mac with private sector participants is political theater and does not address the fixing that is really needed to reshape the mortgage lending landscape. Best and brightest management people paid in Wall Street dollars are needed to right Fannie and Freddie. Save the feigned outrage, get the right people on the bus and let them navigate Fannie and Freddie to the center of the mortgage universe.
Erasing Fannie Mae and Freddie Mac from the mortgage landscape will leave a void that market forces will fill quickly with a too-big-to-fail risk/return model with a federal government safety net. Smart financial and political people will argue to the contrary but the institutional structure of our interdependent financial markets will force this outcome or risk collapse, it is how our engine runs. We will replace what we have with a trust evoking new name, a fluid risk aversion mission statement and overwhelming lobby forces muting consumer needs. There will be no baseline underwriting standard to stray from, private sector players will create their own, beginning with a maximum return/ minimum risk code that will evolve as the mortgage markets absorb paper.
There will be new legislation to manage the new financial labyrinth of lending guidelines and product offerings. Pricing will be market driven and absent any incentive to manage consumer access to mortgage financing. Consumers will be priced or underwritten out of the opportunity to buy a house. The playing field will tilt away from the striving and remain open for only the sure thing, it is that way now, it will become more so.
Replacing Fannie Mae and Freddie Mac as a constructive consequence to the mortgage meltdown is akin to pulling over when the check engine light comes on and changing a tire, the fix has nothing to do with the problem. Life after Fannie Mae and Freddie Mac will be pretty much what it is now, except more deregulated, more expensive and further behind the velvet ropes, other than that . . . we’re good.