Opinion

Who Should Take The Risks In The Mortgage Market?

Peter Roff Contributor
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It’s often said the definition of insanity is to do the same thing over and over again while expecting to get a different result. Not surprisingly this appears to be a lesson lost on the head honchos at Freddie Mac and Fannie Mae who, having made risky plays that almost toppled the American financial system and cost taxpayers at least $187 billion in bailouts – we may never know the real number, which is probably much higher – keep trying to perpetuate their existence and put things back the way they were.

Congress is considering legislation to force these two Government Sponsored Enterprises, also known as GSEs, to share much more of the risk with private sources of insuring against borrower defaults on the mortgages they purchase, package and securitize. It’s a complicated issue, one that is not easy to explain without sounding like a banker or the manager of a hedge fund. Suffice it to say that the idea is to swap out the government guarantee for private forms of insurance.

Fannie and Freddie have been doing this in moderation for a few decades with private mortgage insurance on low down payment mortgages which historically absorb the first 30 percent or so of any losses. Without private insurance the bailouts would have been worse by about $50 billion. The private mortgage insurance industry has said its ready, willing, and able to do more and to provide “deeper cover” insuring 50 percent of the loan value.

To refuse to use this source of private capital and instead let the GSEs continue insuring as much risk as they have in the past is the functional equivalent of inviting the fox over to watch a movie in the henhouse. Things may start out all right but everyone from the farmer to the fox to the hens knows the odds are pretty high that things will end badly.

The right play, the obvious play, as a bi-partisan group of senators recently explained in a letter to Mel Watt, the former North Carolina Democratic Congressman who now heads up the Federal Housing Finance Agency, is to put private capital in the so-called “first loss position” pushing the GSEs into a more remote second or catastrophic loss position for losses when borrowers default. “The credit risk transfers are a vehicle for moving the housing market forward by attracting private sector investors, improving access to credit, and reducing taxpayer risk,” the senators wrote. They want the FHFA to “prioritize” its work so that the government sponsored enterprises that took us down the wrong path last time will not be in a position to do so again.

We shouldn’t be surprised that private mortgage insurance backed by private capital can better assign risk and has a more realistic picture of the market because it lives or dies based on the accuracy of its estimates. The private insurance market is also not subject to political pressure like the GSE’s – whom politicians in either party can and have squeezed in order to rev up activity in the housing market to, let’s be honest, win votes.

Not surprisingly the GSEs recognize this threat to their resurgence and are attempting to co-opt the idea of such “risk sharing” or the use of “credit risk transfers.” Rather than enlist private capital on the front end, which is to say before the loan ever gets to Fannie and Freddie, they have been doing “back end” deals where they warehouse all the risk (and take all the premiums) and only then start to unload some of the risk (and only a part of the premium revenue) to another entity. This allows the GSE to keep most of the profit — and control who gets the deals. That’s why it’s important for Congress to force them to do the right thing; they won’t do it on their own.

Analysts have said, in more ways than one, that the way housing is financed in America must from this point forward be on a firm and stable foundation in order to avoid any future crash. A sound market is a better place for people to do business than an unstable one – meaning access to credit, properly insured in the private markets may actually go up rather than decline as those who think the government-first solution is the only way to go happily predict.

Having the private market play a bigger role than the government is actually a way to help people stay in their homes in recessionary times. The government doesn’t really care if a person walks away from a home they can no longer afford; but the bank that holds a mortgage and the private insurer of that loan do — and do so to an extreme degree. This is why the role for the private insurers should be expanded. It’s better for everyone. Congress would be foolish to let Freddie and Fannie take back control of what they once had. That, as we now all know, turns out to be a bad deal for the homeowners, the banks, the investors, and the American taxpayers.

Peter Roff is a senior fellow at Frontiers for Freedom, a Washington-based public policy organization and a commentator who appears on regularly on the One America News network.