Part 3: Will government ever get its act together on housing?

The hous­ing indus­try is suf­fer­ing, in part because the struc­ture of our nation’s finan­cial mar­kets does not allow us to escape from past mis­takes. To a sig­nif­i­cant degree, this inabil­ity to break with the past can be directly blamed on a fed­eral gov­ern­ment that clings to its own inept­ness and forces the mar­ket­place to adjust for the mis­man­age­ment of the two GSEs, Fan­nie Mae and Fred­die Mac.

As dis­cussed last week, I pro­pose the cre­ation of a new type of mutual fund, the mort­gage mar­ket mutual fund (MMMF). So, pre­cisely how would an MMMF function?

At least ini­tially, the loans pur­chased by the MMMF would not be exist­ing loans, but rather newly-minted loans which banks and other mort­gage orig­i­na­tors choose to sell. And the mort­gages pur­chased by MMMFs would not be mort­gage backed secu­ri­ties (MBSs), but rather entire pack­ages of loans fully owned by the MMMF. At the point of pur­chase, the MMMF would decide whether to con­tinue using the bank as a mort­gage ser­vicer — so as to hold down oper­at­ing costs — or to develop those ser­vic­ing capa­bil­i­ties in-house.

As pur­chasers of pack­ages of mort­gages, MMMFs would rely upon the due-diligence efforts of mort­gage orig­i­na­tors (e.g., banks) to insure that only finan­cially respon­si­ble bor­row­ers are pro­vided new mort­gage monies. At least two ways seem fea­si­ble to insure respon­si­ble loan-granting deci­sions by orig­i­na­tors. First, the MMMF could chal­lenge pur­chased loans that are later deemed irre­spon­si­ble in a court of law. One need merely exam­ine the poor per­for­mances of mort­gage orig­i­na­tors up through 2007 to see the need for such MMMF protection.

A sec­ond safe­guard would be for loan orig­i­na­tors to rein­vest some funds in the MMMF for each pack­age of mort­gages sold. So, for exam­ple, mort­gage orig­i­na­tors might rein­vest 3 to 5 per­cent of the loan package’s price back into the MMMF. In that fash­ion, the mort­gage orig­i­na­tor has some “skin in the game” and is more likely to be thor­ough in pro­vid­ing sound, secure mort­gage loans.

With the estab­lish­ment of MMMFs the need for Fan­nie and Fred­die could come to a much-desired end. And like the S&Ls of old, this 21st cen­tury model would pro­vide an envi­ron­ment for peo­ple (savers) to loan funds to other peo­ple (mort­gage bor­row­ers) through a private-sector entity (the MMMF) with­out involve­ment by gov­ern­ment. It would also pro­vide savers a new out­let for invest­ing their monies. In addi­tion to the huge vol­ume of finan­cial assets held in mutual funds, small savers now have nearly $6 tril­lion in sav­ings accounts and cer­tifi­cates of deposit (CDs). Presently, the inter­est rates on such sav­ings vehi­cles are pre­pos­ter­ously low, such as the aver­age 5-year CD rate on Feb. 2 at 1.16 per­cent. Not only does this abysmally low rate not even cover likely infla­tion, it fails to accom­mo­date for the tax­able nature of inter­est income. So why do some peo­ple still invest? Because there are no rea­son­ably safe alter­na­tives. That’s where an MMMF could pro­vide much-needed com­pe­ti­tion to banks for the funds of savers.

How might an MMMF be struc­tured to serve poten­tial investors? While the pre­cise struc­ture of any MMMF would be estab­lished in a prospec­tus, at least a cou­ple of gen­er­al­ized forms seem rea­son­able. Whether for a direct invest­ment or for those who invest through a tax deferred sav­ings vehi­cle, the MMMF might sim­ply be part of a fam­ily of mutual funds from which to choose, with the MMMF monies grow­ing over time.

As an alter­na­tive, some MMMFs may be struc­tured to per­mit a “pass-through” type of arrange­ment where, after the pur­chase of a pack­age of mort­gages, both prin­ci­pal and inter­est are repaid to investors over time. Such an MMMF arrange­ment may be attrac­tive to investors largely inter­ested in gen­er­at­ing income rather long-term asset growth.

Should this solu­tion to the on-going fund­ing cri­sis in hous­ing be uti­lized, it must be rec­og­nized that as a pre-condition for MMMFs to exist and pros­per, the Fed­eral Reserve would need to end its active manip­u­la­tion of inter­est rates. In the same way that America’s savers are being pun­ished by cur­rent Fed poli­cies, such manip­u­la­tive efforts might eas­ily harm MMMF investors.

The time has come for our nation’s lead­ers to set aside polit­i­cal pos­tur­ing and elim­i­nate the role of Fan­nie and Fred­die in mort­gage mar­kets through a market-driven replace­ment such as the MMMF. With the costs to tax­pay­ers now north of $150 bil­lion and climb­ing, the timely deaths of Fan­nie and Fred­die will likely be mourned by few Americans.

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 29 2012. You can follow any responses to this entry through the RSS Feed. Comments can be made below.