Part 2: Will government ever get its act together on housing?
Imagine you are aware of two companies that, over the past few years, have managed to record losses of more than $150 billion, with the potential for red ink flowing as far as the eye can see. Would you expect to see these companies continue to operate and shake down unsuspecting investors for more funds to stay afloat?
Chances are most of us would answer “no” and anticipate a quick end to couple of corporate losers. Sadly, the U.S. government is sustaining two such failures with that number of losers potentially rising to three in the near future — and American taxpayers represent the unsuspecting “investors” described above.
On Sept. 6, 2008, the nation’s two government sponsored enterprises (GSEs) charged with advancing the goal of home ownership — Fannie Mae and Freddie Mac — were placed under government conservatorship. Through years of poor decision making and relying upon an implicit government backing, these for-profit GSEs obtained relatively cheap funds and allowed their private investors to profit handsomely. Unfortunately the GSEs failed, with taxpayers (unsuspecting public investors) footing a bill that presently runs more than $150 billion.
Despite the failure of Fannie and Freddie, these two enterprises are still very much alive. Along with the Federal Housing Administration (FHA), which also underwrites government-backed mortgage loans, Fannie/Freddie/FHA now account for approximately nine-of-10 mortgages in the U.S. Even more depressing, FHA now seems on the verge of needing its own government bailout and may soon represent the newest member of this triumvirate of taxpayer-supported failures.
Virtually everyone agrees that the exposure of taxpayers to on-going losses from Fannie and Freddie must end. Periodically, politicians trot out the issue during an election cycle and lament the lack of effort in reforming Fannie and Freddie. Perhaps rather than reforming Fannie and Freddie, the two GSEs should be prohibited from involvement in new home loans and should simply ride out their remaining lives based upon servicing the mortgage instruments they have already obligated American taxpayers to guarantee, all of which raises the possibility of billions more in losses to American taxpayers. But at least, moving forward, this would allow mortgage markets to begin healing and qualified home buyers to obtain funds without the anchor of Fannie and Freddie’s past failures holding them down.
Clearly, such a solution requires a new means of providing mortgage monies for borrowers, a solution that provides a sizeable quantity of funds but without involving government. In short, a market-driven alternative to the failed Fannie/Freddie model.
So, how does one go about identifying such an alternative? As it turns out, the history of our financial sector provides a clue, but with the modern-day spin needed to eliminate past government intervention. Specifically, the guidepost is the savings-and-loan association. Historically, S&Ls were institutions which would allow large numbers of people to deposit funds (and earn a rate of interest), with those funds then establishing the reserves needed to provide loans to homeowner-wannabes. In effect through S&Ls operating as financial intermediaries, one set of people provided home loans to another set of people. To be sure, in that earlier form government was involved via the FSLIC, the savings-and-loan equivalent of FDIC, with the S&L industry and FSLIC needing its own government bailout beginning back in the late 1980s.
So, what subsector of the present financial world has the size needed to absorb such a potentially huge volume of transactions without government involvement? The mutual fund industry.
Presently investors can invest monies in various types of mutual funds including stock, bond and money market mutual funds. Such investments can be channeled through a tax deferred account — such as 401(k) and 403(b) plans — or through direct investments. And the quantity of funds here is massive, with the Investment Company Institute estimating $24.7 trillion worldwide in mutual funds at the end of 2010, of which $11.8 trillion was based in the U.S.
In an effort to tap into these huge volumes of funds, and to give savers a wider range of options with potentially improved rates of return, I propose the creation of a new type of mutual fund — a mortgage market mutual fund (MMMF) where both large and small investors could pool their resources and purchase mortgages from loan originators.
How would this mortgage market mutual fund provide a market-based solution without the heavy, and exceedingly costly, hand of government being involved? That will be the final piece of the housing puzzle to be discussed next week.
Dr. James Newton serves as chief economic advisor to Commerce National Bank and is an auxiliary faculty member in economics and statistics at OSU-Marion and OSU-Newark. Dr. Newton’s views do not necessarily reflect those of Commerce National Bank or OSU-Marion/Newark.