The most glaring omission from the Dodd-Frank financial reform act is without a doubt the lack of a plan for Fannie Mae and Freddie Mac. The government-sponsored enterprises remain encumbered with billions in toxic loans, and unfortunately, the movement to fix these institutions has been stuck on the back burner–until now. The Treasury Department has announced it will hold a conference on the future of Fannie and Freddie on Aug. 17. A Congressional hearing will be held in September.
The administration seems bent on offering a concrete proposal in January, which is welcome news, as the travails of these entities are costing taxpayers a lot of money. So far the tab stands at $145.9 billion; it will likely end up topping $380 billion–which would make it by far the most expensive bailout effort to date.
What sort of solutions will be discussed? I doubt anyone will argue that having some sort of body that guarantees mortgages and sells them for securitization is a bad thing. The key will be to somehow retain the salutary effects of this process, which can lower costs, expand the ability of lenders to make home loans, and protect lenders from rate shocks.
Taking the long view, the rise of securitization has been a welcome development. The real estate crash has revealed that there’s a down side if you let securitization run amok. One theory, as noted by the New York Times, is that this process has led to lax lending. “If mortgage issuers passed along the default risk to Freddie Mac and Fannie Mae or to the buyers of mortgage-backed securities, those issuers would have little incentive to screen borrowers properly. While issuers often do have some skin in the game, the enormous amount of both securitization and sloppy lending during the boom made it natural to link the two phenomena.” Indeed, defenders of Fannie and Freddie have long argued that they were pressured to start guaranteeing non-prime loans, to expand the homeownership pie. On top of all of this, securitization has made it harder for loans to be worked out. These are certainly reasonable theories.
The bottom line is that securitization of mortgage loans based on a sound lending standard is a good idea. But how best to do that? Perhaps the biggest issue is whether the government has a role in subsidizing this effort. And if so, what exactly is that role? What are your ideas?