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.

Posted by Jim Newton on Feb 21 2012. You can follow any responses to this entry through the RSS Feed. Comments can be made below.