Why the Feds Want to Stay in the Mortgage Game

Shuan Donovan will moderate the Future of Housing Finance ConferenceThe future is here, and not a moment too soon. Tomorrow, Treasury Secretary Timothy Geithner and HUD Secretary Shaun Donovan, pictured left, will host a conference on the future of housing finance. Before you click away or fall asleep -- pay attention. What's at stake is nothing less than whether or not you -- or the buyer to whom you'll sell your house to one day -- will be able to get an affordable, long-term mortgage, no matter what the state of the economy.

Fannie Mae has been guaranteeing this since 1938, Freddie Mac since 1970. Their original mission was to level out the ups and downs of mortgage lending by creating giant pools of money for home loans that banks could dip into whenever they needed it, whether those banks were flush with deposits or had hit a dry spell.

Of course, the Fannie and Freddie story has had a much-less-tidy ending, as deregulation led private competitors to undercut them with subprime lending – and Fannie and Freddie made a fatally bad decision: "If you can't beat 'em, join 'em." They're now both under government conservatorship.

Some critics, like former Federal Reserve Bank of St. Louis chief William Poole, have suggested that the United States doesn't need institutions like Fannie and Freddie anymore, because the private sector has now figured out how to turn mortgages into securities and sell those to investors.

We all know how well that worked out last time around.
But let's say that the Dodd-Frank financial reform bill will rein in the worst abuses of borrowers and investors, and will keep the mortgage banking of the future from imploding. Let's also assume that a healthy level of market discipline will prod investors in mortgage securities to make rational choices about their risks. Even then, what we're looking at with a purely private mortgage market would likely be big cycles of feast or famine for consumers seeking mortgages. Sometimes, too few funds would be available to borrowers, or on terms that were so conservative – big down payments, short duration of loans – that they'd put big financial burdens on borrowers. Then at other times, at the other extreme, plenty of funds might be available but mostly for the wrong kinds of loans – the very riskiest.

Think about how investors do business. Sometimes they panic, and keep all their money on the sidelines – like they've been doing in the last couple of years as the credit markets collapsed. But when the market surges back, as it must do eventually, investors are going to want to chase the highest returns – and you can bet that the highest returns will come on the mortgage products that are the least consumer-friendly. Mortgage products that borrowers now take for granted as an affordable way to buy a home – like the 30-year, fixed-rate home loan – could become a thing of the past.

If widespread homeownership is going to be part of the American landscape, some force needs to be out there making sure that it is, while minimizing the risk to taxpayers that they'll get stuck holding a big bill. That's the agenda that Geithner and HUD Secretary Donovan have already put out there, testifying to Congress this spring. Now the secretaries are putting on their own show to air different points of view on that idea.

Tomorrow's conference features a top-flight crew of housing and finance experts, and not just from academia – among them will be Lewis Ranieri, who at Salomon Brothers not only, essentially, invented the private mortgage-backed security, but who lobbied Congress and the White House to make it legal for Wall Street to trade in mortgages with next-to-no government oversight. While Ranieri defends his invention as vital to a healthy mortgage market, even he acknowledged in comments recently submitted to Treasury that "federal government support of housing is essential."

What the Obama administration is really trying to do tomorrow is come out strong in support of a sustained government role, and have the debate become about how, exactly, to best make that role effective – not about whether or not the feds should be in the mortgage business at all. Because once it gets to Congress, the fight over what to do with Fannie and Freddie is going to get ugly. And if the administration isn't careful, the drama could make health-care reform, "death panels" and all, look like an easy win.

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