What if the two government-owned housing agencies that backstop so many of the nation's mortgages ceased to exist? A new report from an influential think tank says that's what should happen.
But while the plan isn't quite as radical as it first sounds, if implemented it would mean a significant change if another housing bubble builds and bursts -- a change that would have more of the risk falling onto individual homeowners instead of the federal government.
"Housing America's Future: New Directions for National Policy" was authored by the Bipartisan Policy Center, a Washington, D.C.-based group founded by former Senate luminaries Howard Baker, Tom Daschle, Bob Dole, and George Mitchell.
Among other things, the report recommends slowly winding down Fannie Mae and Freddie Mac -- the government-owned housing agencies that had to be bailed out at great taxpayer expense after the most recent real-estate bust -- and replacing them with what the report's authors call the "Public Guarantor."
Taking the heat off taxpayers and putting it on homeowners
As the name suggests, the Public Guarantor would serve a similar function as Fannie and Freddie, but with a twist that would take the heat off the taxpayer in the event of another catastrophic housing-market event, like the one we saw in 2007.
Right now, Fannie and Freddie buy mortgages originated by the nation's banks, package them up into mortgage-backed securities, and sell them to investors. In return, Fannie and Freddie pay interest on the securities back to the investors.
But unlike Fannie and Freddie, the Public Guarantor wouldn't buy mortgages or issue mortgage-backed securities. The private sector would now handle that. And in the event of another burst housing bubble, the Public Guarantor would only guarantee investors their interest payments and the return of their initial investments.
This guarantee would only be triggered after the private capital in line ahead of it had been exhausted. Specifically, the government would be fourth in line to take a loss, which means, of course, the taxpayer is also fourth in line.
Mission accomplished, right? Yes, but it's a double-edged sword.
Goliath Wins This Match, for David's Own Good
While it's great that the taxpayer is less on the hook for mortgage-market trouble, that default risk has to land somewhere.
With this new plan, part of that somewhere is back onto the borrower, who would be first in line to take the hit if the Public Guarantor guarantee is ever triggered. Next in line after borrowers are private-credit enhancers and finally the corporate resources of mortgage issuers and servicers.
So in the end, under this proposed plan the government would only be giving an ironclad guarantee to investors in privately issued mortgage-backed securities.
Why favor the big investor over the little homeowner? Because investor demand for mortgage-backed securities is what drives demand for mortgage lending in the first place, thus allowing the little guy to get his mortgage at all.
There simply aren't enough investors who will buy mortgage-backed securities without some sort of backstop from the federal government. Over a 30-year period, the time span of popular U.S. mortgages, there's just too much risk of default, even with borrowers who have good credit. So the only way to keep enough liquidity in the home-lending market -- and therefore ensure that qualified people who want home loans can get them -- is to guarantee the big-time investor.
Taking on homeowner-default risk is the whole reason the government started supporting the housing market to begin with, all the way back in the 1930s, when the Federal Housing Administration was created. The private-lending market wouldn't take the risk on all by itself then, and it won't take it on now, either.
Not to Worry, Nation
So under this proposed plan, ultimately the taxpayer is still on the hook but would gain some protection from the vagaries of the housing market. It would come, however, at the expense of the homeowner.
If any of this frightens you, keep the following in mind: This report and its recommendations is a nonbinding report by a nongovernmental bipartisan institution -- even if it is an influential one.
Bipartisanship isn't exactly the watchword of the day in Washington. (If there's one thing partisans from the left and the right typically find common ground on, it's their dislike of wishy-washy, weak-spined bipartisans.) So, while the recommendations in the report are interesting and potentially game-changing, nobody in Washington has to pay any attention to it. So they probably won't.
John Grgurich is a regular contributor to The Motley Fool. Follow his dispatches from the bleeding heart of capitalism on Twitter @TMFGrgurich.