The goals of the proposal in the white paper are to ensure that Americans have access to mortgages in all market conditions, while making private capital the dominant funding source for housing and protecting taxpayers from a repeat of the $150 billion rescue of the two government-sponsored firms during the financial crisis. The paper was written by Milken Institute Senior Fellow Phillip Swagel, a professor at the University of Maryland School of Public Policy and former senior official at the U.S. Treasury during the financial crisis.
"While government guarantees of mortgages are needed for the foreseeable future to ensure that Americans can obtain mortgages at reasonable rates, housing finance reform must be done in way that protects taxpayers against future bailouts," Swagel said.
The proposal in the paper is consistent with the options being considered by the Treasury Department for reforming the mortgage finance system.
Sell Fannie and Freddie
Returning Fannie and Freddie to private hands and allowing other firms to compete with them will foster an innovative housing finance system for the benefit of American homeowners. "Competition will best drive innovation and ensure that the benefits of government involvement in housing go to homebuyers in the form of lower interest rates," Swagel wrote.
Standardize Mortgage-Backed Securities
Standardizing the instruments involved in securitization to create a common form of MBS would be a helpful step in the transition to a better housing finance system. Swagel maintains that standardizing MBS would immediately improve liquidity and thus lower interest rates today, and would ensure that this liquidity continues as new firms enter into securitization in the future.
Expect Higher Interest Rates
With Fannie and Freddie now controlled by the government, taxpayers effectively stand behind the firms′ guarantees on new mortgages but without proper compensation. The proposal in the white paper would change this.
Reform likely will lead to higher mortgage interest rates. According to the paper, this is not a problem to be avoided, but a consequence of protecting taxpayers by putting private capital ahead of them. A secondary government backstop is still important, however, because without it interest rates could rise by hundreds of basis points, and hundreds of thousands of homes would go undeveloped or unsold.
The alternative to reform is for Fannie and Freddie to remain in conservatorship and for the government to play a dominant role in housing finance. "This would be the worst outcome for the U.S. financial system, the overall economy and future homeowners, who would not benefit from the innovation and competition that only the private sector can bring about," Swagel emphasized. "The longer the GSEs remain in conservatorship, the more likely it becomes that they remain there forever — and that taxpayers take on all the risks of housing finance. Now is the time to move forward with reform."
"Reform of the GSEs and Housing Finance," sponsored by the Clearing House Association, is available at www.milkeninstitute.org.