Tuesday, August 14, 2012

To Privatize or Not?

The newly appointed running mate of Presidential Candidate Mitt Romney, Paul Ryan has proposed the following regarding Fannie Mae and Freddie Mac: "The housing-finance system of the future will allow private-market secondary lenders to fairly, freely and transparently compete, with the knowledge that they will ultimately bear appropriate risk for the loans they guarantee. Their viability and profitability will be determined, not by political favoritism, but by the soundness of their practices and the value of their services."

Fannie Mae and Freddie Mac are companies that ensure (or are supposed to ensure) quality in mortgage loan files to be ultimately bundled and sold to investors. One of the biggest issues with Fannie and Freddie over the last ten years is they co-mingled the mortgages sold to investors. Sub-prime, commercial and A-paper loans were all bundled into the same investment and sold. Investors were mislead on the risks involved in the asset. When sub-prime loans started defaulting, it brought down "so called" A-paper securities and unraveled the implied trust in the securities outstanding and for sale. Currently former executives of Fannie are being sued by the SEC over these issues.

The main argument against privatizing (mostly from politicians) is that without a government guarantee, mortgages will become more expensive to the consumer. Well, over the past ten years we have seen interest rates go to ridiculously low levels because our government is purchasing these mortgage securities. It is a false market. So, are mortgages inexpensive now, or are they artificially low to stimulate our housing market. We can all agree the latter is the case. The free market will undoubtedly intervene and the costs will self regulate. Besides, over the last four years we have seen numerous companies receive government assistance that at no time had an implied guarantee.

Ultimately, it is the responsibility of these two companies (GSEs - Government Sponsored Entities) to ensure that the mortgage loans that are bundled into investments represent the implied quality of the investment. This is the strong hold - this is what creates investor confidence - designed to stimulate the purchase of these investments. Well...Fannie and Freddie have failed at this. So, if they failed once with their current structure, why will they not fail again if the same structure is left in place?

In the end, mortgage investments will get purchased because they are a good investment. Having the government behind them didn't prevent the mortgage meltdown and it will not help going forward. Our housing market would be much better served by privatizing mortgage securitization firms (Fannie and Freddie are securitization firms). Common sense lending could be a dream come true, the costs would self-regulate, competition and transparency would help ensure quality, and investors will purchase the securities because of return on investment.