Denationalizing Housing in America. Calling on the Private Sector
How is it that financial institutions are flooded with capital, and, paradoxically, the federal government is drowning in debt? Even more confounding is that financial institutions and private sector investors are in dire need of interest earning assets but can’t find the right investment opportunities. All the while, the federal government is saddled with assets it can’t unload.
We Americans are entrepreneurial and resourceful at our core. If we believe in something and have the right moral and economic incentives and imperatives – private and public sectors come together to get it done time and time again. With that in mind, I would like to see bigger ideas or “BHAG”s (Big Hairy Audacious Goals) from this Administration to create partnerships between the private and public sectors to get us out of this recession. Where are the big ideas or goals to restore the housing industry? Where’s our “man on the moon" like challenge for housing?
To that end, if the housing market requires a federal backstop for the foreseeable future, than they should be paid handsomely for assuming that risk. Fannie Mae and Freddie Mac receive a mere 25-35bps for their guarantee to investors, and Ginnie Mae makes roughly 6bps for their investor guarantee. With interest rates at all time lows, now would seem to be the time to make those risk premiums substantially higher then where they are priced today. Eventually, if the premiums are determined to be higher than the true risks embedded in the government's role as head underwriter, then we can expect private capital to seize the opportunity and offer more competitively priced risk insurances. That is also a step towards denationalizing housing.
Private capital does exist and has the will and incentive to invest in the housing market. Private capital is available in abundance and is ready to be invested, just not at the prices that many sellers and the Administration want them to be priced. We can’t look at market demands as binary – if the bid /ask is too wide then the government should close the gap by buying all the assets themselves!
What the Administration should consider doing is looking for partnership opportunities with private capital – risk sharing, senior subordinate structures, etc.. For example, the GSEs (Fannie and Freddie) are repossessing hundreds of thousands of homes a month but struggle with weak market demand that ultimately drives prices down and loss severities up. Private capital is swarming over these assets but are looking to buy low and flip the properties for tidy and quick profit, which the GSEs resist and most often choose, understandably so, not to sell in those circumstances.
As an alternative to inaction, we would offer the following model: Promote a model that allows REOs to be sold at the highest bid price (market price) to private investors in bulk and/or to individuals but require equity sharing on properties that are resold within 10 years? HUD has long used a MPDU (moderately priced dwelling units) that has similar requirements and restrictions for buyers of “subsidized homes”.
This sort of partnership would clear REO inventory, restore capital at the GSEs, bring patient private capital to the market, provide much needed returns for investors, and give taxpayers a share of equity recovered (50% if sold or cashout refinanced in the first 10 years).
Another opportunity for private capital partnership would be in the area of purchasing mortgage-servicing rights from servicers that continue to struggle to effectively mitigate GSE losses. In some cases, the GSEs are making the business decision to buy MSRs at presumably above market prices (otherwise they would have already been sold or would be bought by someone other than the GSEs) and then partnering with specialty servicers that have had better success at loss mitigation and default management , i.e. get better results for the GSEs then current servicers.
While we applaud the idea in principal, why instead wouldn’t the GSEs partner with private capital to buy MSRs at the market price (private capital in 1st position) and provide mezzanine funding (government in 2nd position) above the private capital to meet the sellers asking price. Given the GSEs depleted capital levels, this would seem to be prudent and create higher utilization of their limited financial resources without affecting the goal of improving loss mitigation results. Similar structures could be used to recapitalize the GSEs and other housing Agencies, and could even offer solutions for the ticking time bomb of MBS trustees that could require substantial federal backstops.
There is no big bang solution to denationalizing housing. If these were uncomplicated problems they would have been solved already. We need to stop bashing and start getting creative. Creativity starts where all product and service innovation originates – the private sector.