The American Mortgage System: Crisis and Reform

13. Improving U.S. Housing Finance Through Reform of Fannie Mae and Freddie Mac: A Framework for Evaluating Alternatives

C h a p t e r 1 3 Improving U.S. Housing Finance Through Reform of Fannie Mae and Freddie Mac: A Framework for Evaluating Alternatives Ingrid Gould Ellen and Mark A. Willis As was noted in Chapter 1, the government-sponsored enterprises (GSEs) known as Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation)1 were, until recently, the largest players in a U.S. housing finance system that provided mortgage financing for millions of Americans. Since early 2008, the firms’ insolvency has called their future into question. This chapter lays out criteria for evaluating proposals for reform of the two firms. After we introduce the basic goals of a healthy secondary market for both the single-family and multi-family markets, we offer a framework that will help to describe and understand the different proposals for reform and how variants of Fannie and Freddie might fit into that picture. Goals of a Secondary Market for Housing Finance A number of proposals have been put forward to reform the structure of the GSEs since they have been put into conservatorship. In considering these options for reform, policymakers should start with the basic goals of the sec- 306 Ingrid Gould Ellen and Mark A. Willis ondary market as part of the overall housing finance market. For the purposes of this analysis, we assume that the laws against discrimination and unfair and deceptive practices are being enforced and that the risks inherent in different mortgage products are transparent to borrowers and so-called toxic products are generally not available. In this light, the following broad principles seem essential: • Access to liquid credit markets nationwide. The primary goal of a secondary market is to ensure a deep and broad market for mortgagebacked securities that provide financing for both single-family and multi-family borrowers across the country.2 Higher debt liquidity helps to ensure a reliable and consistent source of capital. It reduces variations across regions in rates and availability for the same mortgage products, and it results in better pricing of securities and ultimately lower mortgage rates for borrowers. • Countercyclical stability. The secondary market should help to ensure consistent access to credit throughout economic cycles.3 The secondary market should provide credit during downturns to help stabilize the housing finance market and should not expose taxpayers from unnecessary bailouts of the GSEs or their successors. The secondary market should not encourage easy availability of credit or aggressive underwriting during periods of expansion. Finally, a wellfunctioning secondary market should not exacerbate the impact of an economic downturn by impeding the ability of servicers to modify loans or authorize short sales to help avoid unnecessary foreclosures. • Availability of safe products that are reasonably priced and clearly understood by borrowers and investors. Some mortgage products are less prone to default than others. Given that these products minimize the risk of harm not only to borrowers but also to their children and neighborhoods, government has an interest in ensuring that these products are available and widely used. An example might be the 30-year, self-amortizing, fixed-rate mortgage with the option to prepay. With this product, borrowers have known and fixed monthly payments, and investors can properly assess the risks of investing in the mortgage-backed securities (MBSs) that are backed by these types of mortgages. Improving U.S. Housing Finance 307 • Provision of credit for the underserved. The secondary market should help to ensure that appropriate products and resources are available , for both single-family and multi-family mortgages, in markets that would otherwise be underserved because of misconceptions about the degree of credit risk or because of higher origination costs or lower fees (e.g., smaller loans, even if not harder to originate, will generate less revenue from a given amount of up-front points or the same interest-rate margin). A Framework for Evaluating Reforms Before evaluating any particular proposals, it is useful to articulate a framework by which to compare and contrast them. We lay out nine characteristics that can be used to distinguish among different approaches for reforming the secondary market, indicating in each case how critical that feature is to meeting the goals laid out previously. Credit Enhancement Arguably the most critical feature of any proposal is the existence and nature of any credit enhancement, or guarantee, provided. Since the Great Depression, insurance and guarantees provided by the...