Save Fannie and Freddie

The Obama Administration weighed in yesterday with a its list of options for the reform of the US housing finance system. I've just downloaded the report and will read it over the weekend and have some more commentary on it from back in São Paulo this week.

However, I do have some preliminary impressions based on a number of press reports.

As we all remember, abuses of the housing finance system, both at the retail level and at the securitization level caused the financial crisis that the US is still trying to recover from — the Great Recession. Impossibly generous loans were made to people who could not afford them. Fannie Mae and Freddie Mac bought mortgages without studying or understanding the makeup of the pools that were selling off. Investment banks (RIP, Lehman Bros.) then chopped up these guaranteed mortgage investments and further securitized them with all manner of alphabet soup investment products, most of which were doomed to fail.

So, after the $135 billion federal bailout and takeover of Fannie and Freddie (should be called a takeback since they started out as federal institutions and were hived off to the private sector in a previous wave of conservative transference of power from the "socialist" US government to the private sector), both the Obama Administration and especially the conservative Republicans who arguably hold sway in Congress want to privatize the system even more and do away with Fannie and Freddie (very gradually and based on the rate of recovery in the housing market) according to Timothy Geithner, US Treasury Secretary.

The Obama Administration is offering three alternatives to replace the current system, all of which greatly reduce the government presence in the housing market. Unfortunately, I believe that all will prolong the housing crisis in the US by making lenders less willing to take on new borrowers and keep housing prices depressed especially in middle-class areas of America's cities. They will prolong the crisis by raising the rates that banks will need to charge for housing loans to meet the charges they will have to pay.

Why does the US government participate so actively in the housing market? Since the Great Depression of the 1930's, it has been a goal of the American government to encourage housing ownership and has supported mortgages for lower-income Americans through a variety of programs that guarantee loans for these borrowers and provide a long-term home for loans that banks make so they can recycle the money to make new loans. This is the securitization that led to the problems in 2007 - 2008. Fannie Mae and Freddie Mac (along with a number of other parallel institutions for specialized markets that the government never turned over to private administration) were the institutions created for this purpose. Banks sell pools of their mortgages to the securitizers who then package them into investment instruments that that for many decades were a safe, sound investment vehicle.

Then, both the board of Fannie and Freddie along with the private mortgage industry got "cute". All in the name of expanding the opportunities for Americans to participate in the dream of owning their own home. It is not my purpose here to review the gamut of abuses of the system that took place during the last decade, but the system became distorted beyond recognition.

Now, the solution in government is to throw the baby out with the bathwater. Killing off Fannie and Freddie (no matter how gradually) and replacing the core system of mortgage securitization with some watered down, pablum version represents a serious withdrawal from America's commitment to housing availability.

It would be a much better solution to focus on the lending standards and standards for securitization and leave versions of Fannie and Freddie in place to provide the tool for banks, particularly in smaller communities, to resell their mortgages and encourage the health of the housing market. In another effort stemming from the Dodd-Frank financial reform bill, government agencies are struggling to define what is a qualifying mortgage, one that makes it much less likely to fail. These efforts (called QRM or qualifying residential mortgage) are keeping lobbyists employed in Washington right now. Defining a standard that will reduce abuse potential but keep reasonable loans available will occupy the industry's attention for much of 2011. The target date for a federal regulation, April 21, simply will not be met. There are too many interests involved trying to defend their turf.

However, the QRM battle and both government and exchange rules about some of the housing related derivatives that no one managed to understand even in their heyday are the correct arenas to have these reform discussions, not killing Fanny and Freddie because they were abysmally administered.

I can understand Republicans and Tea Partiers not wanting any "government" participation in the housing market. After all, that's their meme. But, I'm sad to see President Obama retreat so far from his commitment to fundamental American goals.