I recently read an article titled “Fannie and Freddie must go – here’s how”. The authors are Richard Kovacevich, retired Chairman & CEO of Wells Fargo and William Isaac, Global Head of Financial Institutions at FTI Consulting and former Chairman of the FDIC. Below are the main points of the article. Read them and you decide if this will benefit the Honolulu real estate market.
Background
The recession of 2008, precipitated by the collapse of the subprime mortgage bubble, may be over, but America’s economic growth is weak. The housing market must be strengthened. Yet in the past three years, there has been no progress on the housing front and Washington policymakers seem clueless as to how to turn things around.
Congress wants to raise mortgage fees charged by Fannie Mae/Freddie Mac to pay for the payroll tax extension. Some lawmakers assert this will eventually lead to getting the government out of the mortgage business. It’s unclear how increasing fees charged by Fannie/Freddie encourage the government to wind down these agencies. Raising mortgage fees during the worst housing slump since the Great Depression will not stimulate housing or job creation.
Subprime mortgages have existed for decades, but they were well under 10% of the mortgage market until Fannie/Freddie reduced credit standards to meet low-income and minority home ownership targets mandated by Congress. By 2007, nearly 50% of U.S. mortgages were subprime and Fannie/Freddie guaranteed about 70% of them.
Bank regulators warned Congress for decades about Fannie/Freddie’s risky portfolios, but those warnings were ignored. Without government guarantees, the subprime bubble and the resulting financial crisis probably would not have happened. Since Congress failed to act, nearly the entire developed world is suffering from the mortgage-induced recession and U.S. taxpayers are on the hook for hundreds of billions of dollars of losses at Fannie/Freddie.
Steps to Mortgage Reform
The solution is straightforward: The public/private hybrid of Fannie/Freddie should be abolished, their existing business sold or liquidated and the mortgage market privatized. This can be done in an orderly way in a few easy steps.
- Fannie/Freddie’s existing portfolio of mortgages should be sold at a rate of about $75 billion a year until it reaches zero.
- The current $625,500 limit on new mortgages guaranteed by Fannie/Freddie should be reduced by $100,000 per year, to ensure both agencies are out of the guarantee business within six years.
- The liability for any outstanding guarantees should be managed by the current government conservatorship of Fannie/Freddie until they run off or are sold.
- If the government still wants to provide mortgages for low-income families or minorities, it should be on budget and be transparent. The Federal Housing Authority already exists to do this.
Some say this puts the American home ownership dream at risk. Consider this; the United States is the only major country in the world where the government is heavily involved in the mortgage market. Yet, the home ownership percentage in the U.S. is less than two percent higher than most developed countries and countries like Canada have higher percentages than the U.S.
Some speculate that mortgage rates would skyrocket and the 30-year, fixed-rate mortgage would cease to exist without Fannie/Freddie. However, non-conventional or “jumbo” 30-year mortgages not guaranteed by Fannie/Freddie have existed for decades.
In the decade preceding the financial crisis, the interest rate on these jumbo non-conventional mortgages averaged just 0.25% higher than similar guaranteed mortgages. That’s just over $40 a month on a $200,000 mortgage. Shouldn’t Americans, like homeowners throughout the world, pay an extra tax-deductible $40 per month so taxpayers aren’t on the hook for hundreds of billions to bail out Fannie/Freddie?
It’s time for Congress to do what it should have done decades ago; get the government out of the mortgage business so taxpayers are never at risk again.
