President Obama’s groundbreaking call last week to wind down Fannie Mae and Freddie Mac and to put private capital at the center of the housing finance system represents a welcome antidote to the decades-long market distortion caused by the inordinate market share held by those two GSEs. But it also raises questions about how responsive the free market would be, particularly in light of recent news out of California.
When Fannie and Freddie went into conservatorship in 2008, they had 50-odd percent of the market of one- to four-family housing, and since then, have expanded it to 90 percent, by doing loans at the longest terms in history at the lowest rates in history – in other words, loans that no one else would make. Obama wants to see a more market-based approach, in which the private sector, with its own skin in the game, would take the lead in risk, rather than taxpayers, and would bring market-based stability to the housing sector rather than the false stability of an implicit government guarantee.
The National Association of Realtors supports Obama’s plan, calling it close in structure to the NAR’s own. It said that a market-stabilized system would provide credit to borrowers even in economic downturns. That’s commendable, but it would probably — and logically — do so at a price. Private markets are likely going to want to be able to risk-base their pricing in order to keep the market viable.
The NAR calls for preservation of the government guarantee in any restructured secondary mortgage market to preserve 30- and 15-year fixed-rate loans. It expresses concern that in a fully privatized market, many middle-class people and those on fixed incomes would be unable to access affordable credit, or they’d have to take adjustable-rate mortgages.
It’s often said that homes serve as the largest middle-class investment. But the word “investment” in that context is far different than its definition by regular investors. For the middle class, the home is a financial baseline. For investors, it’s a commodity. So while the government’s wish is to stabilize the housing market, the private sector is going to want to get paid, to put it bluntly.
And that brings us to California. The city of Richmond wants to use eminent domain to seize more than 600 private mortgages that are currently underwater, despite two thirds of them being still current on payments, and refinance through the taxpayer-supported FHA, pool them into a new security and resell them to other private investors. The stated intention is to give homeowners a break. But another beneficiary would be the advisory firm that floated the idea. The potential losers: mortgage bond trustees, three of which have brought suit.
If the government wants to bring the private sector into the housing tent, it would be wise to keep in mind that investors don’t like deals in which the rules change halfway through.
