1. The Future of GSEs In America
Anthony B. Sanders
Senior Scholar
Mercatus Center at George Mason University

2. Whither Fannie Mae, Freddie Mac, and FHA?
• Best analogy is a taxi cab medallion
• License to operate with government guarantee
• Only FHA, Fannie Mae and Freddie Mac have them
• Cost of the medallion?
• NY City Taxi Cab Medallion recently sold for $1 million
• The cost of the government guarantee medallion is far
more expensive (affordable housing goals)
• All three medallion holders are chasing affordable
housing goals (aka, risky lending)
• Are Government subsidized mortgage rates the “other”
entitlement along with mortgage rate deductions?

3. Should There Be A Medallion?
• No, the private market should price risk rather than
government
• Policy since Clinton (National Homeownership Strategy)
has so devastated the housing finance system (low
down payment mortgages, streamlined underwriting,
aggressive marketing, councilors, etc.) that we have
government capture of mortgage markets:
– >90% government control of residential
securitization
– Add HECM and student loan capture …
– Need to avoid creating a 100% FHA market!

4. The Result of Crowding Out By Government
“There’s simply no such thing as a nonguaranteed housing
finance market, other than in ideological fantasies.” Adam
Levitin, Georgetown University, Sept, 2011
•This sentiment is echoed by many in the finance industry
– That is, no one will buy our MBS without a government guarantee
– If this is correct, then SOMEONE has to hold the medallion
– The question is WHO and HOW MANY?
•Spreads between GSE 30 yr MBS and 10 yr Treasuries reveal
that Fannie/Freddie MBS are just Treasury substitutes.
– Private label MBS could attract more investors with higher yields

5. Their Talking Points
• Product Availability Lower
– 30 Year, fixed rate, callable mortgage will not exist FALSE
• Banks continue to originate and hold 30 year FRM
– Homeowners will have to take more risk, will not be able to match duration
of their largest asset GOOD
• LESS TEMPTATION TO SPECULATE AND GO FOR THE MAX
– 3-5 year ARMS with prepayment penalties will be the norm, putting more
risk upon households GOOD
• ARMS FORCE BORROWERS TO CONSIDER HIGHER PAYMENTS IN FUTURE,
WILL CONSUME LESS HOUSING (DON’T CONFUSE THE ARM BEHAVIOR
IN THE BUBBLE WITH NORMAL BEHAVIOR)
– Much larger TBTF banking system will be needed, with government support
in another form BIGGER THAN FANNIE AND FREDDIE?
• NOT TRUE. THERE IS NO REASON TO BELIEVE THIS ARGUMENT.

6. Their Talking Points
• Level of Rates Higher
– Level of mortgage rates will be 100 to 250bp higher
PROBABLY TRUE
• Historically, the jumbo-conforming spreads has been
30 basis points, back to Clinton Spread history shows
that private RMBS market had more volatile rates SO?
• Why should taxpayers subsidize lowering rate
volatility, particularly when The Fed is already doing

7. Their Talking Points
• Costs to Society will be higher
– Taxpayer bailouts will be more expensive AS OPPOSED TO THIS MELTDOWN?
• NO REASON TO BELIEVE THIS IS TRUE
– Homeownership will be lower, fewer good borrowers will qualify PROBABLY
• CLINTON PUSHED HOMEOWERNSHIP SO HARD WE BROKE THE SYSTEM.
WHAT’S WRONG WITH RENTING?
– Labor mobility will be lower UNLIKE PEOPLE TRAPPED TODAY?
• MANY PEOPLE ARE TRAPPED IN THEIR HOMES THANKS TO
GOVERNMENT HOUSING POLCIIES ALREADY
– Main monetary policy transmission mechanism will be diminished NOT TRUE
• MORTGAGE REFIS ARE FASTER ON PRIVATE LABEL MBS, SLOWEST ON
GINNNIE MBS

8. Back To The Pre-Securitization Days
• No securitization, bank balance-sheet lending only
– Regulators feel banks are already too exposed to real estate
– But banks have staggering amounts of reserves available (although
“sterilized” by Fed
– Regulatory knot (Fed, FDIC, OCC) – too much regulation
• But Dodd-Frank restricts bank lending
– QRM definition is restrictive and only applies to originators, not to
medallion holders (Fannie Mae, Freddie Mac, FHA
– Even if something is done with the GSEs, Dodd-Frank represents a
significant hurdle to repairing the mortgage market
• Perhaps 50% of $10 trillion mortgage market
– If you want the mortgage market to shrink, stop securitization (Warning:
unintended consequences alert!)

9. Securitization
• The devastation caused by well-intended national housing policies
may have left us with no choice: a medallion is required
• But WHO gets to hold the medallion if that is the path that we
choose?
– All banks (originators) hold limited medallion (risk sharing with
government)
– Convert Fannie/Freddie to reinsurance companies with NO retained
portfolios (Do we need two?)
– FHA? Difficult to control and massively inefficient. Shut them down.
• To prevent a repeat of history, I suggest a cooperative form of
ownership among originators
– Even a mutual approach to ownership could work, but less cooperative
(utility) would remove the “hog trough” problem

10. Risk Sharing Approach Between Government And Originators
 Level 1: Quality Mortgage Loans
 Minimum Down Payment, no second liens
Down payment 20%
 Strict UW Standards and Appraisal Requirements
 Full Recourse to borrower (State laws?)
First loss to Originator  Level 2: Separately Capitalized Originator Insurance
Initially 5%  Subordination based on extreme stress scenarios
(going to 30%)
 Standardized structures capitalized by valuable assets
 Non-rescindable insurance contract or subordinate bonds
 Originator earns profits over time instead of booking it all
upfront. Capital in SPV accrues in tax advantaged way.
 Reps and Warranties hit this first , no debate, no delay
Reinsurance from  Level 3: Government Medallion Wrap
Gov’t
Value  Bond holder looks to Federal government for full faith and
Initially 95%
of credit guaranty
the (going to 70%)  DANGER: Potential problem with Administration and Congress easing
loan the wrap rules (such as 3.5% down payment, 5% first loss to
originator and 95% to taxpayers (aka, government). And this is a
SECOND BEST SOLUTION, not the best solution (no government
medallion).

11. Cooperative Structure: More Detail

12. Preferred Futures of GSEs
Preferred Solution
•Bank portfolio lending
•Securitization with no medallion (government guarantee)
•No affordable housing mission*
Second Best Solution (most likely)
•Partial medallion to all originators (risk sharing with government)
•Cooperative or mutual ownership structure
•Fannie/Freddie as reinsurance companies
•No affordable housing mission*
Third Best Solution
•Keep Fannie/Freddie in place, but with strict oversight (Warning: danger!)
– No retained portfolio, transparency on loan purchases, no affordable housing mandates, etc.
Multifamily?
•Spin off from Fannie/Freddie, use cooperative structure, no medallion
– Already have FHA/GNMA programs
*Note: HUD still retains rental programs, so affordable housing mission is on balance sheet.

13. 10 Year Phase In
•Whether we go with a cooperative or mutual ownership structure with
Fannie/Freddie as reinsurance companies, or some other future, I suggest
TAKING IT SLOW and PHASING IN CHANGES.
•The last time we accelerated housing policy (1992-1999) we moved too fast
and created a monster.
– Federal Housing Enterprises Financial Safety and Soundness Act of 1992
• Act also established HUD-imposed housing goals for the financing of “affordable housing,”
housing in central cities, and housing in rural and “other underserved” areas. HUD has
periodically raised the goals.
– National Homeownership Strategy: Partners in the American Dream” – 1995
– Removal of Capital Gains Taxation on Housing – 1997
– Financial Services Modernization Act of 1999
•Taken together, these well-intended policies had horrible consequences
– Let’s provide STABILITY and take our time rather than rushing for the lifeboats on
a sinking ship

14. 10 Year Phase In Non-Agency MBS Issuance Has
Disappeared

15. But Private Label MBS Are Still Issued

16. U.S. Homeownership Rate—The Great Leap Forward

17. Home Price History

18. Fed Policy and Home Prices

19. Growing Bank Holdings of Agency MBS

20. MBA 30 vs FNMA Current Coupon – Spread Widened in Dec
2008

21. Different View of Bank Rates vs Fannie CC Rate

22. Jumbo-Bank Rate 30 FRM Spread
Pre and Post Crisis

23. Fannie 30 CC vs 10 yr Treasury CMT
90 Basis Point Spread

24. TBA Shows Fannie 30s Barely Above 10 yr Treasuries

25. Example of Fannie Multifamily Deal

26. Sterilized Bank Reserves

27. Clinton-era Mortgage Rates

28. References/Additional Reading
• FHA’s Instant Undertow Mortgage
– http://confoundedinterest.wordpress.com/2012/04/27/fhas-instant-undertow-mortgages-3-5-down-in-a-declining-home-price-environm
• National Homeownership Strategy and the Clinton Housing Trifecta
– http://confoundedinterest.wordpress.com/2012/04/20/parsons-blames-glass-steagall-repeal-for-crisis-but-glass-steagall-was-only-13rd-o
• Dangers of the Administration’s 14 Loan Modification Programs
– http://confoundedinterest.wordpress.com/2012/04/22/senate-proposal-for-expanding-harp-taking-off-the-safety-features/
• FHFA and Principal Reductions
– http://confoundedinterest.wordpress.com/2012/04/10/fhfas-demarco-no-trial-principal-reduction-yet/
• Krugman on Bush Creating the Housing Bubble
– http://confoundedinterest.wordpress.com/2012/01/26/krugmans-misleading-tale-of-two-bubbles-a-closer-look-at-the-data/
• TBA for Private Label MBS?
– http://confoundedinterest.wordpress.com/2012/03/07/tba-or-not-tba-that-is-the-question-do-we-need-the-federal-government-guaran
• Reuter’s Mortgage Write Down Calculator
– http://confoundedinterest.wordpress.com/2012/04/18/reuters-uber-cool-mortgage-write-down-calculator-loss-to-taxpayers-of-128-billi
• Fannie/Freddie had 30%-40% share of “subprime” from 2001-2008
– http://confoundedinterest.wordpress.com/2011/12/19/sec-versus-fannies-mudd-and-freddies-syron-it-boils-down-to-the-definition-of-s
• Do We Need the 30 year Fixed-rate Mortgage?
– http://mercatus.org/publication/do-we-need-30-year-fixed-rate-mortgage
• Andrew Davidson, GSE Reform: Risk Sharing and Cooperatives, 2012. Paper at Federal Reserve of Atlanta.

29. Contact Information
• GMU Web: http://mason.gmu.edu/~asander7/
• Mercatus Web: http://mercatus.org/anthony-b-sanders
• Email: asander7@gmu.edu
• Phone: 703-993-1326

30. Destination Unknown: The Future
of GSEs in America
Dr. Arnold Kling
Mercatus Center at George Mason University
akling4378@gmail.com
Presentation in Washington, DC
May 2, 2012

31. The Way Forward: Mortgage
Finance in a Post-GSE World
Lawrence J. White
Stern School of Business
New York University
Lwhite@stern.nyu.edu
Presentation in Washington, DC
May 2, 2012

32. “The shapers of the American mortgage
finance system hoped to achieve the security
of government ownership, the integrity of
local banking and the ingenuity of Wall
Street. Instead they got the ingenuity of
government, the security of local banking and
the integrity of Wall Street.”
David Frum, National Post, July 11,
2008

33. “..the GSEs play an extraordinarily successful
double game…[telling] Congress and the news
media, ‘Don’t worry, the government is not on
the hook’ – and then turn around and tell Wall
Street, ‘Don’t worry, the government really is on
the hook.”
Richard Carnell, Senate testimony,
February 10, 2004

34. “It’s only when the tide goes out that you
learn who’s been swimming naked.”
Warren Buffet

35. Deep Throat* (Hal Holbrook): “Follow the money.”
Bob Woodward (Robert Redford): “What do you
mean? Where?”
Deep Throat: “Oh, I can't tell you that.”
Bob Woodward: “But you could tell me that.”
Deep Throat: “No, I have to do this my way…”
“All the President’s Men” (1976)
*Now known to be Director: Alan J. Pakula
W. Mark Felt, Writer: William Goldman
Deputy FBI Director

36. Overview
•Housing and subsidies
•The failures of Fannie and Freddie
•How to avoid future bailouts of the housing finance system
•What about “affordability” and “accessibility”?
•What about the 30-year fixed-rate mortgage?
•Where will mortgage finance come from?
•How to get from here to there
•Other needed long-run reforms
•Conclusion

37. Housing is heavily subsidized
•Fannie & Freddie
•FHA, VA, USDA, Ginnie
•Income tax deductions for mortgage interest, state & local
government taxes
•Capital gains exclusion
•Subsidies for builders
•Direct provision by government (“public housing”)

38. Consequences of heavy subsidy
•Households buy more house!
– Larger, better appointed houses on larger lots
•Because of subsidies, U.S. housing stock is 30% larger;
U.S. GDP is 10% smaller
•Income tax deductions and exclusions mostly benefit
upper income households
•Effects on home ownership rates are modest (at best)
– Subsidies for purchase mostly encourage households that
would have bought anyway to buy bigger
– Where is the social benefit in that?

39. The Failures of Fannie & Freddie
•Too many high-risk mortgages were held and securitized
– This began in the mid to late 1990s
•Not enough capital
– Only 2½% capital for mortgages held in portfolio
• Supposed to cover credit risk and interest-rate risk
– Only 0.45% capital for securitized mortgages
• Supposed to cover credit risk
– Banks and S&Ls are required to hold 4% capital just to
cover the credit risk on mortgages!
•The U.S. Treasury’s capital contribution so far: more than
$180 billion

40. How to avoid future bailouts of the
housing finance system
•Require more capital for “systemically important financial
institutions” (SIFIs)
•If size generates negative externalities, put a tax on size
– Much better than the sledgehammer of a forced breakup
•Cut back on government guarantees
– Limit guarantees to FHA, VA, USDA, Ginnie
– Be clear-eyed that the focus is to help (properly screened) low/
moderate-income first-time home buyers
– Expect on-budget moderate losses
– Eventually replace with down payment assistance

42. How to avoid future bailouts of the
housing finance system
•Require more capital for “systemically important financial
institutions” (SIFIs)
•If size generates negative externalities, put a tax on size
– Much better than the sledgehammer of a forced breakup
•Cut back on government guarantees
– Limit guarantees to FHA, VA, USDA, Ginnie
– Be clear-eyed that the focus is to help (properly screened) low/
moderate-income first-time home buyers
– Expect on-budget moderate losses
– Eventually replace with down payment assistance

43. What about “affordability” and “accessibility”?
•“Affordability” is a code word for widespread subsidy
– Income redistribution is best done through income transfers, not
through subsidizing specific goods
– The pre-2007 differential between conforming (F&F) loans and
jumbos was only approximately 25bp (0.25%)!
•“Accessibility” is a code word for mandates
– Why does a profitable service need to be mandated?
– And if it’s not profitable…
– If the real issue is discrimination, then address that directly and
prosecute vigorously

44. What about the 30-year fixed-rate mortgage?
•Jumbo (unguaranteed) 30-year fixed-rate mortgages have
been and continue to be available
•The major issue with 30-year fixed-rate mortgages is
interest rate risk; but government guarantees cover only
credit risk
•Insurance companies and pension funds are natural buyers
for long-lived obligations
– But pre-payments are a problem
•Pre-payment fees need to be part of the answer
– The “free” pre-payment option adds about 50bp to mortgage
interest rates

45. Where will mortgage finance come from?
•Expanded depository lending
– Depositories held 30% of mortgages in 2007 (not including
MBS)
• Despite all of the subsidies/advantages for F&F
– Covered bonds may provide modest help
•Simplified, clarified private-label securitizations
– Simple tranche structures
– Insurance companies and pension funds are natural buyers
• Life and P/C insurance companies: $6.7 trillion in assets
• Private, state, local, federal pension funds: $10.5 trillion in assets
• Less than 6% of these assets are currently held in MBS

46. How to get from here to there
•Fannie & Freddie plus FHA/VA/USDA/Ginnie currently
account for over 90% of mortgage originations
– They are crowding out private-sector involvement
•Start winding down/selling off F&F’s mortgage portfolios
•Reduce the F&F conforming loan limit by 10% per year
– Reduce FHA’s limit by 10% per year until it is 20% below
median house prices
•Raise guarantee fees by 5bp per year

47. Other needed long-run reforms
•Cut back on housing subsidies generally
– Start portraying a house as just another asset, not special
– Replace lending subsidies with down payment assistance
– Make renting respectable
•Reduce resource distortions that make housing more costly
– Local land-use zoning
– Restrictions on lumber imports from Canada
•Make recourse the norm in mortgage lending
Will reduce strategic defaults
Will discourage excessive leveraging
•Give the primary lender the power to approve a second lien
– This is standard in commercial lending

48. Conclusion
•Housing and housing finance are important
•Good policies can make a big difference
– So can bad policies
•Sooner is better than later