REFinBlog

Editor: David Reiss
Brooklyn Law School

September 4, 2018

Housing Finance Transitions

By David Reiss

image by NCTC Creative Imagery/USFWS

The Congressional Budget Office released a report, Transitioning to Alternative Structures for Housing Finance: An Update. The report updates a 2014 analysis

to inform policymakers about how different approaches to restructuring the housing finance system would affect federal costs, risks to taxpayers, and mortgage interest rates. The study focuses on the secondary mortgage market, in which financial institutions buy residential mortgages, pool them into mortgage-backed securities (MBSs), and sell the securities to investors with a guarantee against defaults on the underlying loans. That market is dominated by Fannie Mae and Freddie Mac, two government-sponsored enterprises (GSEs) that have been under the control of the federal government since the financial crisis of 2008.

• Federal Costs. CBO projects that under current policy, the GSEs will guarantee almost $12 trillion in new MBSs over the next 10 years and that those guarantees will cost the government about $19 billion on a fair-value basis. That cost represents the estimated amount that the government would have to pay private guarantors to bear the credit risks of the new guarantees. New structures for the secondary mortgage market that emphasized private capital would greatly reduce federal costs, compared with current policy, and would decrease taxpayers’ exposure to credit risk, but mortgage borrowers would face slightly higher costs.

• Risks to the Government. Three of the four approaches to restructuring the secondary market that CBO analyzed would keep some type of explicit federal guarantee of MBSs to provide stability to the market during a financial crisis. Under those approaches, the government would continue to bear most of the risks on new guarantees during a financial crisis, but the approaches differ in the extent to which private guarantors and investors would share risks under normal market conditions. Alternatively, if the secondary market were largely privatized, there would be no explicit federal guarantees on most residential mortgages. But some type of government intervention might be necessary to stabilize mortgage markets during a financial crisis.

• Availability of Mortgages and Changes in Interest Rates. New structures for the secondary market that emphasized private capital would lead to slightly higher interest rates and slightly lower home prices under normal conditions (because the fees that the GSEs currently charge for their guarantees are close to the prices that CBO judges private firms would charge). If the market were controlled by a single, fully federal agency, interest rates could fall slightly. During a financial crisis, however, borrowers could face significant constraints on the availability of mortgages and higher interest rates under a largely private secondary market, though not under the other structures, unless the government chose to intervene.

This report is particularly valuable because it focuses on the transition from the limbo state of conservatorship that we find ourselves in to a more stable one that is built to last. The report considers four possible pathways:

  • A secondary market in which a single, fully federal agency would guarantee qualifying MBSs. (1)
  • A hybrid public-private market in which government and several private guarantors would share the credit risk on eligible MBSs. (1)
  • A secondary market in which the government would play a very small role during normal times, but would act as the “guarantor of last resort” during a financial crisis. (2)
  • A largely private model in which there would be no federal guarantees in the secondary market. (2)

Things still are very much up in the air as to which way things will go when Congress finally turns its attention to this issue, but this report helps to plan for the transition no matter which path is followed.

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