Can We Survive Without Fannie and Freddie?

Should the government directly guarantee mortgage-backed securities?  That’s the most provocative aspect of a proposal put forward by Jim Millstein, who oversaw the restructuring of AIG at the Treasury when it was taken over by the government.   His views were given a great deal of coverage in Monday’s Wall Street Journal and if you believe, as I do, that sooner or later the government will have to grapple with what to do with Fannie and Freddie, he raises some interesting points to consider, even if you don’t drink all his Kool Aid, which I certainly don’t.

First, if you wave a magic wand and do away with Fannie and Freddie tomorrow, there would be no housing market in this country because there would be no financing.  The GSEs are involved with more than 90% of all new mortgages over the last four years.  What’s more, a decreasing number of banks hold onto their mortgages and right now the only places interested in buying these mortgages and packaging them into securities are Fannie and Freddie.  Remember that Fannie and Freddie charge the buyers of the mortgage-backed securities a guarantee fee against default, which means that your taxpayer dollars used to bail out Fannie and Freddie were actually being used to bail out bondholders.   Millstein proposes that Fannie and Freddie should no longer provide this guarantee and that it should instead be provided directly by the government.   He argues that the government already insures bank and credit union accounts, so why not provide the same protections against mortgage risks?

The second part of his plan would make a regulator responsible for assessing the quality of mortgages before they are securitized; again this sounds more radical than it actually is given how much the government has taken over housing policy.  The government has already decided that the CFPB should determine what constitutes a qualified mortgage eligible for greater legal protection.

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