How to fix Fannie and Freddie to give Americans affordable housing

Housing is a huge component of America’s economy, standing around 15 percent of gross domestic product (GDP), which is roughly the same as healthcare. Fannie Mae and Freddie Mac hold $4.6 trillion in mortgage-backed securities, which is about a quarter of the nation’s annual GDP. While we have considered government-sponsored enterprise (GSE) reform for years, Fannie and Freddie are about to hit two critical deadlines that impact their permitted reserves and retained capital in the next 18 months. Good and thoughtful decisions need to be made imminently.

Criticism of GSEs emanates from mostly doctrinal partisans on one side or another. On one hand, we have the traditionalists who maintain that the great Fannie and Freddie policy “sin” was allowing them to privatize and manage their own portfolio risk while maintaining an implied federal guarantee. On the other hand are those who believe that Fannie and Freddie should never have existed at all, and further, that now is the time to revisit the flawed Depression-era thinking that created them.

Supporting one view or the other are the stakeholder communities understandably interested in assuring that their particular ox is not gored. All the while, the net worth of the American middle class and our affordable housing finance capacity is trapped in the middle of these arguments. The legislative field over the last eight years is littered with GSE reform proposals, which can be bookended, in a manner of speaking.

{mosads}On the one end was the Housing Finance Reform and Taxpayer Protection Act, commonly referred to as the Johnson-Crapo Act, which sought to end Fannie and Freddie and offered a weak alternative to secondary market support. On the other was the Jumpstart GSE Reform Act, which supported affordable housing but, similarly, seemed ambivalent about the needs for secondary market liquidity.

Both efforts were unsuccessful. Why? Largely because each proposal sought to unwisely solve a financial problem through politics. The political class’s doctrinal concerns fail to address a fundamental problem: Fannie and Freddie’s existence directly impacts both first-time homebuyers’ ability to own and the net worth of a significant portion of the American middle class. The two entities fund significant investment in our affordable housing market, so we need to focus on how a functioning secondary market can provide adequate liquidity that can mitigate risk at minimal taxpayer expense.

Fannie and Freddie essentially act as the housing market’s spleen, moving mortgages into and out of the markets after original (primary) issuance and facilitating risk management in the housing finance marketplace by providing desperately needed liquidity. Our last economic crisis caused a liquidity problem that was largely solved when conservatorship invoked the GSE’s implied federal guarantee. Everyone hated it, but that support helped saved a much worse outcome for American homeowners.

Sens. Mark Warner (D-Va.) and Bob Corker (R-Tenn.) are currently working on a plan that breaks up Fannie Mae and Freddie Mac. Their policy goal is to recreate a secondary market with more competition. Most agree with the idea of greater competition in the secondary market, but not by constructing a paradigm that would potentially leave homeowners — or finance stakeholders — in the lurch.

The Mortgage Bankers Association organized the Task Force for a Future Secondary Mortgage Market that has offered the most comprehensive and thoughtful ideas for GSE reform thus far, while nonetheless revealing significant flaws. The association proposes a remote, or backup, full faith and credit mechanism available to a variety of stacked private sector performance liquidity vehicles, whereby those de facto credit enhancers take on only market risk. The government (in other words, taxpayers) would become the guarantor of last resort of only the market risk. The model has the added benefit of sustaining the current liquidity needs that support middle class American homeowners with little or no disruption. It is a good starting point.

But the flaws? Credit enhancement markets can be cyclical and notoriously unreliable. They are historically prone to vastly overestimating and underestimating risk. Absence of steady and consistent credit enhancers is critical to the task force’s model. Also, the model contemplates Fannie and Freddie’s long-standing charter commitment to affordable housing, but does little else to explain how that commitment will be assured either practically or in policy. Given the current crisis in affordable housing, the policy articulation in the task force reform proposal merits more thought.

Treasury Secretary Steven Mnuchin maintains that GSE conservatorship is unsustainable, but he has offered no plan. His support for the conceptual goals in the task force proposal would be a great starting point in the reform conversation if the goal is to achieve GSE reform soon. Given housing’s critical importance to the economy, moving thoughtfully while keeping the American homeowner and affordable housing both in mind, as the task force essentially proposes, might make more sense than anything else. Congress and Secretary Mnuchin should consider the task force recommendations and “guardrails” as a solid baseline.

Orlando J. Cabrera served as assistant secretary of the U.S. Department of Housing and Urban Development during the George W. Bush administration. He was also chief executive officer of Florida Housing Finance Corporation, a housing finance agency, and is now a partner in the Washington, D.C., office of Arnall Golden Gregory.

The views expressed by contributors are their own and are not the views of The Hill.