The need for reform of our government sponsored enterprise system has been debated and discussed for several years now. Whether justified or not, the popular opinion that the GSEs played a significant causal role in the subprime meltdown has spurred the industry and government to consider whether or not the system, as it is, works.
Setting aside those debates for a moment and assuming that GSE reform should go forward, many options exist.
We’ve heard talk of totally privatizing the mortgage securitization market. We’ve heard discussion that we simply need to recapitalize the existing GSEs (Freddie Mac and Fannie Mae). We’ve heard alternatives spanning the spectrum of possibilities.
After reviewing the options, however, I strongly believe our strongest course of action would be to combine the existing GSEs into a single, super GSE operated similarly to Ginnie Mae.
In Ginnie Mae, we have a proven business model. Ginnie has been a success story in spite of underfunding and hurricane-like market headwinds in the past 10 years. Why not build upon something that has been shown to work?
For the sake of this discussion only, and for ease of reference, I will refer to this model as “the new entity.” Our first consideration will be where such an entity should be housed.
I've made the case in the past that Ginnie Mae should not be based within the budget allocated to HUD. In short, I believe the budgetary limitations imposed by HUD’s budget and oversight are causing a shortage of resources; an artificial restraint on Ginnie’s ability to seek capital investment and even a disincentive to top industry talent which would otherwise consider joining the corporation.
Therefore, it would be best if the new entity was a stand-alone structure, answering to perhaps a five-person committee appointed by and accountable to Congress. Another option would put the new entity, along with its sister, Ginnie Mae, under the supervision of the Federal Housing Financial Administration, the mission and budget of which is much better aligned with the missions of Ginnie and the new entity.
The new entity would operate in a manner quite similar to Ginnie Mae through its public/private hybrid model — perhaps even exceed Ginnie’s ability to function like a private corporation. I would encourage the setup of this new corporation (no longer a GSE…this would, like Ginnie, be a wholly-owned government corporation) to allow as much latitude for growth and calculated risk as possible.
The best private corporations are those which show vision; invest in reasonable risks and execute at the highest levels. Although this freedom would have to be tempered by public policy and a view of the greater economic good (rather than solely the good of the shareholder), it would be the role of the FHFA to ensure that this balance be maintained.
I would even go so far as to recommend the establishment of a private Board of Directors. Under this scenario, a board consisting solely of private sector executives would be appointed (perhaps by Congress) outside of the governing body (FHFA or Congressionally-appointed commission). While the final word would rest predominantly with the Congressional Commission or FHFA where public needs clash with private, this Board could keep alive the entrepreneurial spirit needed to help such organizations adapt and thrive in times of change.
Ginnie Mae’s ability to make decisive moves during the Great Recession, such as dramatically increasing the role of global investors, is what allowed it to succeed as the market sunk. The new entity should have some element of entrepreneurialism to counter the inevitable slide into bureaucratic deadlock or stagnation. This would also ensure that the new entity would be adequately staffed and capitalized, giving it the resources for growth and innovation while empowering it as an economic backstop to the housing industry.
The other primary features of the new hybrid should be very similar to those which have helped Ginnie thrive. The first, of course, is the explicit guarantee. Some have opposed the introduction of the explicit guarantee into the current GSEs, arguing that it only exposes the government and the taxpayer to greater risk while indirectly giving the government greater influence over what critics believe should be a private market.
However, we saw the limits of the implicit guarantee during the mortgage crisis that began in 2008. Its boundaries were tested severely. If anything, the explicit guarantee offered by Ginnie gave comfort to the secondary markets as portfolios disintegrated under historic waves of foreclosure and REO-activity. It is no accident that the FHA and VA loans went from being niche vehicles to workhorses during this period.
Of course, the necessary counter-weight to offering the rigidity and obligation of an explicit guarantee is that said guarantee should only cover the principal and interest of the loans in question. In other words, like Ginnie, the new entity should not actually securitize mortgage loans in and of itself.
The Ginnie Mae website, as I’ve pointed out before, says it best:
“In the Ginnie Mae program, issuers are financially responsible for their securities, even if the underlying mortgage collateral becomes delinquent. While the GSEs are responsible for the financial losses related to the loans in their investment portfolios and MBS, the Ginnie Mae issuer must make principal and interest pass-through payments to investors for delinquent loans, as well as provide the funds to repurchase loans to foreclose on a home or modify a loan.
Ginnie Mae issuers are responsible for any unreimbursed costs associated with either violating insurers’ servicing guidelines or for inadequate insurance coverage. This requirement provides a strong incentive for private institutions to make better-quality mortgage loans. It is important to note that Ginnie Mae does not have a financial obligation to MBS investors unless the issuer becomes insolvent.”
This pronounced shift in the function of the GSEs is a strong risk-mitigation tool which encourages the market itself to make sound, long-term focused decisions and investments. Will the market make mistakes? Absolutely. But if or when they do, investors will reenter to fray more quickly knowing that the new hybrid entity has contained its financial risks.
I truly believe that building a model which balances the explicit guarantee with a non-securitization function provides adequate protection to our taxpayers while giving that corporation enough distance from the Treasury to maintain at least some amount of free-market autonomy.
The new entity discussed here would have the ability to address the needs of a middle class made up increasingly of immigrants and the Millennial generation. It would have the freedom to find ways to use innovative MI products and it would ensure that the smaller lender could maintain the same liquidity capabilities it has today.
The GSE has proven itself to be an economic catalyst unlike any other. Even if the private market were to take up the role the GSEs play currently, the subsequent interim period (as investors cautiously build up their involvement) could be disastrous for our economy.
While the importance of some federal involvement in the industry cannot be overstated, its latest role in siphoning off the profits of the GSEs is no permanent solution, either. If the new iteration of the GSE is not given some freedom to operate as the most successful corporations do, then it will be unable to adapt to a tumultuous economy…much like many other government bureaus. The new GSE must have a significant level of flexibility in order to keep up with the market.
We already have a blueprint for the next generation of GSE. It has been proven to succeed under historically difficult market conditions. It is time to take this model out to the wider market. I call upon industry leaders such as the Mortgage Bankers Association, Urban Institute, Housing Policy Council and the Miliken Institute to come together to consider this option (and other housing reform options) to create a mortgage industry even better equipped to face the new challenges our economy is already starting to see.
