Don’t Forget About the GSEs (Fannie Mae and Freddie Mac) And Their Government Guarantee

I am speaking today at an American Action Forum event in Washington DC at noon entitled “The Future Of Housing Finance Reform.” Also speaking will be affordable housing guru Laurie Goodman from The Urban Institute with Politico’s Lorraine Woellert moderating.

Meghan Milloy of the American Action Forum penned a nice editorial in advance of the event entitled “Don’t Forget About the GSEs.” Here is a taste:

“It’s been ten years since Fannie Mae and Freddie Mac (the government-sponsored enterprises, or GSEs) went into government conservatorship following the height of the financial crisis. After that much time and a number of new policy challenges in the interim, it might be easy to forget about the GSEs and the financial risks they still pose. This would be a mistake. Fannie and Freddie remain actively dangerous systemically important financial institutions (SIFIs), and their policies have started to slip back to where they were before the crisis.”

The problem stems from the government guarantee, whether explicit or implicit. All the proposals flying around Washington DC all carry a government guarantee in one form or another. And with FHFA Director Mel Watt’s term ending in January, it is time to do something.

In short, I will be recommending returning Fannie and Freddie into the market in a privatized form (releasing them from conservatorship). But without a government guarantee or affordable housing goals. And with a twist.

Ed DeMarco, the previous FHFA Director, attempted to move Fannie and Freddie towards privatization (or shut down) by introducing credit risk sharing notes where mortgage default risk is transferred from Fannie and Freddie to private market investors. But that has been slow moving.

Here is my suggestion.

We adopt the Options Clearing Corp (OCC) model. The OCC clears all listed US equity and index options and is owned by the options exchanges. But the OCC is capitalized by the clearing members (banks and broker/dealers), who also post risk-based margin on behalf of their customers. Default risk is mutualized among the members. While a few large firms dominate the risk (e.g., BAML, Goldman, Morgan Stanley), these same large members are posting the largest amount of risk-based margin and default-fund capital. Mutualizing the risk of the GSEs is the key, just as is mutualizing the risk of the members of a central counterparty. I think the OCC model could work well for the GSEs and the lenders. No guarantee and no affordable housing goals.

Wasn’t that simple?


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