U.S. out of Mortgage Guarantees

By Villani, Kevin | American Banker, October 11, 2011 | Go to article overview

U.S. out of Mortgage Guarantees


Villani, Kevin, American Banker


Byline: Kevin Villani

Congress recently heard conflicting testimony from three professors and one think tank fellow on a simple, straightforward question: Should there be a guarantee for mortgage securities in the future?

Among the numerous arguments for continuing government guarantees:

* We've always had them, since Alexander Hamilton had the Treasury guarantee state debts.

*Bankers always cause financial crises; government always saves them.

*When it comes to the choice of mortgage instruments, underwriting standards, allocating credit among borrowers and designing financing instruments, government always knows best.

*Government guarantees are needed for mortgages to trade and be hedged.

*Mortgage policy is a good way to make the distribution of income more "fair."

*Private markets haven't always worked perfectly, so better to have the government do it.

*Governments provide implicit guarantees, e.g., deposit insurance, so it's better to make them explicit and charge the actuarial price.

This was comical!

Past mortgage market policy caused the collapse of the global financial system and the economy generally, and mortgage markets remain moribund, so the question deserves a more urgent answer.

Perhaps the question was too straightforward. Most analysts would take the question to mean e_SDLqDo third-party capital market investors require the government to act as credit guarantor for mortgage-backed securities?" The two follow-up questions are: "If so, what is the best way to do this?e_SDRq and e_SDLqIf not, what is the best alternative, and what does it require to work?"

But the question Fannie Mae and Freddie Mac proponents actually addressed was,"Should the government allocate housing credit, and if so, how?" And their implied answer was,e_SDLqYes, just the way we did it at Fannie and Freddie with an implicit government guarantee!e_SDRq That's a bad answer to a different question.

Such government allocation of housing credit is almost exclusively the domain of nonmarket economies. Moreover, the public risk for private profit model - unique to the U.S. - is the worst way yet devised to do this, and the root cause of the systemic collapse of the entire financial system. Proponents of credit allocation should choose a better model, one that transparently budgets subsidy costs and doesn't severely distort the financial system!

The straightforward answer to the committee's question is that investors don't require a government credit guarantee for other asset classes, have never requested it for mortgage securities, and have never explicitly gotten it.

The initial motivation for the Ginnie Mae pass-through certificate was to bypass all conflicting state and federal laws and regulations that, among other things, would have required separate security registrations in all 50 states for each offering, making mortgage-backed securities prohibitively expensive relative to whole-loan sales. This bypass was easy because its securities were treated as federal government issues with a federal preemption of state and local laws. …

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