Time to end the taxpayer guarantee of mortgage investors

It is time to reform the housing finance system. Frankly, it was time three years ago when Fannie Mae and Freddie Mac (GSEs) were taken into conservatorship (a fancy way for the government to avoid technically declaring them bankrupt) back in August of 2008. Really, it was time in the early 2000s when the GSEs were going through an accounting scandal and contributing to the housing bubble with their low underwriting standards. Okay, yes, reform was ripe back in 1986 too when the Reagan administration failed to address the deduction of mortgage interest as a part of its broader tax reform.

In short, it has been time to fix government policy towards housing finance for decades, yet no Congress or president has been able to rise to the challenge.

On Tuesday, Fannie Mae announced it lost an additional $5 billion in the third quarter and will require an additional $7 billion from taxpayers. This brings the total taxpayer bailout for the two mortgage giants to an eye-popping $182 billion. Against this backdrop, the chief housing regulator in this country, Ed DeMarco, provided some new fuel to the reform debate when he testified before a House subcommittee last Friday. Noting the difficulty of housing finance reform, Mr. DeMarco warned the GSEs “cannot operate indefinitely in conservatorship” and that “despite the benefits derived from the Treasury support … conservatorship is not a long-term solution.”

At least someone gets it.

Unfortunately, Mr. DeMarco’s current mandate is only to oversee the housing behemoths Fannie Mae and Freddie Mac and to limit taxpayer losses. It’s up to Congress and the president to reform the system. Hopefully with the new public awareness over all the taxpayer losses and bailouts — and the millions Fannie and Freddie employees continue to take home in pay — policymakers will be encouraged to finally act.

A number of proposed solutions have been put on the table, from phasing out the two government enterprises over a five-year period and allowing future mortgages to be financed without subsidies to chartering a new government agency that would explicitly guarantee returns for mortgage investors and subsidize the costs of mortgage credit.

More recently, Rep. Scott Garrett proposed having Ed DeMarco and his colleagues at the Federal Housing Finance Agency design a few standardized mortgage categories to make the private mortgage market more transparent and liquid, so that it does not have to rely on any government guarantees. At the very least, the status quo needs to change. As DeMarco argues, “There seems to be relatively broad agreement that the government-sponsored enterprise model of the past, where private sector companies were provided certain benefits and charged with achieving certain public policy goals, did not work.”

Nevertheless, DeMarco did note that realistically, “there will always be some portion of the housing or mortgage market that will be assisted by government programs, either through direct funding or through guarantees.” The challenge for policymakers is to determine whether or not, and then to what degree, they want to use public resources to subsidize housing for particular groups in society.

For instance, the federal role could be limited to providing financial assistance to just those with incomes below a certain threshold, while the rest of the housing market is financed by investors who don’t need a government crutch.