In a recent Voice of Housing post, I lamented the fact that there seems to be shockingly little public debate underway concerning the future of the US Housing Finance Industry.  I ended that post with the question ... in the industry's future form, is there any role left for the GSEs, Fannie Mae and Freddie Mac?

Intellectual honesty demands that I offer my answers to these questions in the hope that those answers serve as a catalyst for additional public discourse on this important topic. 

The US Housing Finance Industry is like a stool with 3 legs. One of those legs is the "government"-sector leg existing primarily through FHA and Ginnie Mae; the second leg is the "private"-sector leg and functions through large diversified financial institutions such as Bank of America, Citi, Chase, and Wells Fargo; and the third leg of that stool is the "quasi-qovernmental"-sector and functions through Fannie Mae and Freddie Mac.

Today, two of those legs - the "private" and "quasi-governmental"-sectors - are broken.  And the third leg, the "governmental"-sector, is straining mightily under the weight of the burden that has been placed upon it to carry the load during these historic housing crises. To be sure, FHA and Ginnie Mae - and most importantly the many professionals that fill their ranks, have performed heroically during this crises.  Without the success of both organizations in taking up the slack left by the void created in the failure of the other industry sectors, the damage to this nation's economy would have been even more profound and far longer lasting.

It is precisely this interdependence, though, that demands that any plan to recast the nation's housing finance industry be done holistically - with the proper analysis and understanding of the implications and impacts of decisions relating to one of these three critical sectors on the other.  In other words, action to reform the GSEs can't effectively take place without proper consideration being given to the impacts on FHA and Ginnie Mae, and visa versa.  To do otherwise would be like stitching a cut on a patient without giving any consideration to the risk of infection - the bleeding may stop, but the patient may still die.

So, to answer my earlier question concerning the future form of the US housing finance industry, lets begin by focusing on the three "Rs": reform, reorganize and reassure.

Reform: requires that action be taken to reform FHA and Ginnie Mae.

At their core, both organizations are insurance companies - FHA to the extent that it insures lenders against the credit risk associated with defaults by FHA borrowers - and Ginnie Mae to the extent that it guarantees the timely payment of principal and interest to investors in Ginnie Mae securities and thereby insures those investors against the default risk posed by the issuers of those securities.  These roles must be distinguished from the larger  - and I might add, perfectly appropriate - housing policy/program role that is today a key component of the U.S. Department of Housing and Urban Development (HUD).

To accomplish this, FHA and Ginnie Mae should be separated from HUD and permitted to function as an independent, self-funded department of the government, much like the FDIC does today. HUD should be left to function as the government's housing policy/program arm. Among other things, an immediate benefit of this model would be that FHA and Ginnie Mae would be freed from the shackles of the federal budget process and therefore able to staff their organizations appropriately as the demand on them increased. As an example, Ginnie Mae's portfolio in the last three years has increased from approximately $80 billion to nearly $900 billion today. Despite that, the staff of full time professionals at Ginnie Mae remains below 72!  That's right - 72! 

Reorganize: Fannie Mae and Freddie Mac and merge them into a single organization that combines the best of each organization. So to answer my earlier question, unequivocally YES there is an important role for the GSEs in the US housing finance industry of the future - just not in their current form. 

While there were once good and valid to have two such entities, those conditions no longer exist.  Unquestionably, both organizations are populated with very bright, dedicated and hard-working professionals, and each in their own way contribute materially to the essential processes of managing credit risk and providing liquidity to the secondary market. They accomplish this many ways, including, for example, through the development of various credit risk standards and the development and deployment of important technology systems and platforms that today form the backbone of many lenders' underwriting and risk management platforms.  But today, there are many functions within each organization that are redundant.  That is not a slam on either organization but simply a reality of the circumstances in which both organizations existed and grew. Those circumstances understandably promoted competition among them, which in turn contributed to the business decisions they made and this redundancy, among other things. 

There are many ways such"reorganization" could be accomplished. One idea frequently suggested and that deserves further consideration involves the "good-bank" "bad-bank" model, where the companies current whole loan portfolios and securities would be parked in some "bad-bank" entity to manage those assets through their lifecycle while a good-bank - in this case a clean liquidity entity - was formed to support the industry's future credit risk management and liquidity requirements. In this model, the "best-in-class" functions, processes and operations from each respective GSE would be contributed to the new - good-bank entity, if you will.  As envisioned, this "good-bank" entity would be privately capitalized with ABSOLUTELY no government guarantee - implied or otherwise.

Naturally, other good models will be proposed and deserve serious debate and consideration.  And regardless of which emerges as the preferred model, reorganization of the current entities is critical first step.

Reassure: the community of investors world-wide that the US housing finance industry has been reset on a solid foundation. This is accomplished only when all three legs of the stool are rebuilt and reset -  because only then will the requisite level of investor confidence - and in turn private capital -  return to the industry as a replacement for the trillions of dollars that are today coming from the US Treasury. 

Absent such reassurance, a recast US Housing Finance Industry will remain a wish and its renewed vitality will be long delayed.