Recasting the Housing Finance Industry is a Three Step Process: Reform, Reorganize, Reassure
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.