Mortgage market reform from the executive branch

The current administration proposes that Fannie Mae and Freddie Mac be gradually dissolved within ten years by one of three methods:

1. Government-guaranteed mortgages will be available only to finance home purchases by low- and moderate-income families, a task to remain the duty of a much-downsized Federal Housing Administration (FHA). This method will reduce the percentage of mortgages guaranteed by Fannie, Freddie and the FHA — currently around 90% of all mortgages.
2. Mortgage default insurance premiums (MIPs) for government-guaranteed mortgages will be set at a high enough level so private mortgage insurers (PMIs) will be able to compete, thus eliminating the need for a government guarantee.
3. The government will act as a reinsurer of PMIs in case of their failure, for which the government will receive a premium paid by the PMIs.

It is now up to Congress to decide which of the three methods, or which combination of the three, will be implemented. On the mortgage guarantee issue, the “no on everything” contingent now seems to agree that change is needed.

Sure N EZ's take: The administration properly presumes the private sector will step up and fill the void created in the government’s absence. In the past 30 years, Wall Street has shown time and again it can put mortgages on the street at any size and in any volume we need. The private mortgage market was responsible for producing the majority of bad loans during the housing bubble, which is proof they can find plenty of money without the help of Fannie and Freddie.

More important to the discussion of replacing Fannie and Freddie, the PMI industry is fully capable of guaranteeing mortgage performance on a level equal to that of the government guarantee. PMIs understand the reserves that must be set up as they have done so before (unlike Fannie and Freddie), and they will certainly step up to the plate if they have the chance to make more money.

In order to facilitate a smooth transition, however, the housing market must first recover some normalcy before implementation of the changes to phase-out the government guarantee. Fannie and Freddie’s participation will inevitably dissolve as PMIs take over the mortgage market, but now is just not the time to put that process into practice. We must first clean out the bad, nonperforming mortgages through foreclosure.

In the interim, the federal government is fulfilling its purpose during a financial crisis by providing credit to the mortgage-backed bond (MBB) market by guaranteeing, thus reducing the interest rate on mortgages that would otherwise be charged without the guarantee — whether government or private. The private market cannot stay afloat on its own until home sales volume and prices stabilize for at least two years and private MBB investors regain their confidence and recapitalize, probably by 2014.

If Congress wants to jump-start this period of homeownership stabilization, judicial cramdowns for underwater mortgages with loan-to-value (LTV) levels of 94% or more must be restored, as is permitted for investors and businesses both big and small. Cramdowns will make today’s negative equity homeowners solvent and viable contributors to our California recovery.