The propaganda strategy for selling the public on the creation of supposedly new improved GSEs is becoming more apparent. Recall that we had an initial skirmish a month ago, when the Center for American Progress published a plan to reform Fannie/Freddie and the housing finance system. It would create an FDIC-like insurance fund to stand behind private Fannie/Freddie like entities that will offer reinsurance with an explicit Federal guarantee on mortgage-backed securities. These new firms can also be controlled by banks.
This plan, which was very similar to ones presented by the Mortgage Bankers Association, the Federal Reserve and the New York Fed, t was clearly an Administration trial balloon; the CAP is the mainstream Democrat think-tank, with close ties to Team Obama. But after the CAP proposal got some resistance, the Treasury’s report, which came later in the month, went the route of presenting three alternatives rather than a specific plan. But we argued at the time that this seeming change was merely a tactical move, to present the Administration as fair brokers in a politically fraught process, and that it still favored what we called the GSE 2.0 plan.
We think the idea of reconstituting the GSEs in somewhat improved form a terrible idea because it preserves the bad incentives of a public/private system and launders housing market subsidies in an inefficient and unaccountable way through the banking industry (see here and here for more detailed discussions).
So now the challenge for the Administration is to sell this plan without looking like it is selling it. Timothy Geithner set expectations for a long process by saying that the Administration wanted legislation approved in two years. Huh? Nothing important (except extortion exercises like the TARP) gets passed in the months before a Presidential election. Early summer 2012 is the last viable window in this Congress. That’s a lot less than two years, according to my calendar. So more than 16 months is guaranteed to be more than two years. But the message from Geithner is to expect this to take a long time, and that is consistent with trying to build support for their preferred option, which is to create new mini-me GSEs that are made to look more palatable by having better balance sheet support.
The more official PR salvo came in the form of a front page New York Times article, “Without Loan Giants, 30-Year Mortgage May Fade Away.” The argument is that without a government guarantee, there would be no thirty year mortgage in the US.
That might actually be true, but the reasons why provide further proof that this proposal is just another example of throwing taxpayers under the bus to save the banks from suffering the consequences of their incompetence and criminality. We have gotten increasingly specific reports from mortgage investors that they aren’t buying residential mortgage bonds due to the lack of securitization reforms. We have further been told by an industry expert that investors are very worried about the chain of title issues that are leading to gridlock and more and more adverse decisions on standing issues in courthouses all over the US. The only reason they haven’t acted is that they fear applying more pressure on this front will ignite a new financial crisis.
So let us be VERY clear about this: this is GSE non-reform. It’s merely reconstituting the GSEs with better capital cushions but also a full faith and credit guarantee on their mortgages, which is a better backstop than Fannie and Freddie enjoy now. And the only compelling reason for continuing to offer government guaranteed mortgages is to escape exposing and cleaning up mortgage and securitization industry abuses.
The Times is running with the biggest and best threat the fans of this plan can come up with: that the US will lose its much-loved thirty year mortgage without it. We have a new version of TARP type extortion tactics, that of Bill Gross claiming that investors would demand three percent more to invest in mortgages without government guarantees. That’s patently untrue even now. Jumbo mortgages, which were never GSE guaranteed, are now being done at a 75 basis point (3/4%) premium to Fannie and Freddie mortgages (the premium before the crisis was 25 to 40 basis points).
A government guarantee also comes with not-widely recognized systemic risk. Freddie and Fannie engage in hedging on a massive scale to manage the interest rate risk of their exposures. This hedging iss “pro cyclical”, which meant it increased the amplitude of interest rate movements. In 2002 and 2003, Fannie and Freddie hedging had reached the scale where it was economically destabilizing. And as John Dizard described in the Financial Times in 2008, this interest rate risk was also a hazard to Fannie and Freddie themselves.
We can also look to the example of other markets to challenge the need for the new GSEs. No other market, save Canada, has a government mortgage guarantor (I am in the process of trying to read the expert on this topic, since it’s apparently a complicated program). Yet they all have long-dated mortgage products, virtually all also have a high level of middle class homeownership, some like Australia even higher than the US, with no Freddie/Fannie equivalent or other form of large scale government mortgage guarantee program (and you can verify the sort of mortgage products you can get overseas readily; here’s a search tool from Australia, for instance).
The Treasury document subtly argued that it was important to preserve the thirty year fixed rate mortgage, and the New York Times picks up this argument. But a thirty year fixed rate mortgage is not always the best product for borrowers. An adjustable rate mortgage, particularly one with floors and ceilings on interest rate movements (which was a staple of co-op loans in New York in the early 1980s) would in many cases be a better deal. But only a right wing economist (Alex Pollock of the American Enterprise Institute) makes this case; the opposing argument from Susan Wachter, that “There needs to be a systematic way of preventing” fragmentation,” is peculiar and unconvincing. Are the mortgage markets in Britain, Australia, France, and other countries “fragmented”? How exactly are consumer hurt by having more choices? We seem to think that’s a good thing in toothpaste and credit cards; why not in mortgages?
For reasons I cannot fathom, the traditional affordable housing-banking coalition is still holding together on this issue. It should be clear by now that affordable housing programs and mortgage finance are two separate beasts, and the extent of the sops demanded by the banksters mean affordable housing goals will take a back seat. The government should be out of the mortgage finance business; the taxpayer should not backstop risks when foreign markets show that the private sector can handle them perfectly well on its own. Housing subsidies, like the old Section 8 program, can be used to advance important social goals, and should be provided as government programs, with clear targets, performance measurement, and accountability, not as contingent liability timebombs.