A Challenge to the New Congress: Pass Housing Finance Reform

HBS Working Knowledge

Authored Article


It is time for Congress to recommit itself to drafting legislation that will transform housing finance for the twenty-first century, write Nicolas P. Retsinas and Rob Couch.

by Nicolas Retsinas and Rob Couch

Nicolas P. Retsinas is Senior Lecturer in Real Estate, Harvard Business School and former Federal Housing Commissioner. Rob Couch is Counsel, Bradley Arant Boult Cummings and former President of GNMA.

Over six years ago, when the federal government placed Fannie Mae and Freddie Mac into conservatorship, experts from public, private, and academic worlds concurred: housing finance in the United States was mortally flawed. The private sector reaped the gains while the public sector absorbed the risk. In the aftermath of the Great Recession, we needed to design a newer model, one that would not contribute to a plunge in the nation's economy.

But, like Alice's Cheshire Cat, we recognized that to get "there," we had first to decide where we wanted to go—in short, to set the goal of "reform."

The Bipartisan Housing Commission, a diverse group of public policy practitioners from the left and the right, set out to do just that. For the last two and a half years, we co-chaired the Commission's Mortgage Finance Reform Working Group. Remarkably, we saw consensus emerge from both parties on the goals of the new system. We made it as far as the Senate Banking Committee, but fumbled near the goal line. In May, the Senate Banking Committee approved the legislation on a 13-9 vote, but could not garner sufficient support from either side of the aisle to warrant consideration from the full Senate.

For many Democrats, the legislation did not go far enough to support access to credit for working families. For many Republicans, the legislation went too far in providing government guarantees.

The good news was that the Commission had demonstrated that bipartisan support was possible. The Commission (and the legislation) endorsed the following:

  • The 30-year, fixed-rate mortgage should continue as the backbone of the new system. It helps keep monthly payments low, and protects consumers from interest-rate volatility.
  • Given the recent extreme economic stress, Uncle Sam must stand behind these mortgages in the secondary market in order to attract global capital. Without those government guarantees, private financial institutions, recalling the burst housing bubble, would not assume the long term risks associated with these mortgages. (If the private investors were willing to take these risks, they would have. They have not.) Realistically, without Uncle Sam, long-term fixed-rate mortgage financing would be less available, much costlier.
  • In this new system, we need risk-taking private capital. Today the federal government backstops over 80 percent of new mortgages; this is unsustainable. Just as importantly, it imposes an excessive burden on taxpayers. In a stronger, more durable system, private capital would take the "first loss" in the event of a housing market downturn. After a multiyear transition period, Fannie Mae and Freddie Mac should wind down. Unlike the past, the government guarantee should be explicit, fully paid for through the collection of actuarially sound premiums, and triggered only after private capital in the "first-loss" position has been exhausted.
  • Starting in 1993, the federal government set explicit goals for Fannie and Freddie, to ensure that mortgages reached historically underserved families and communities. In this new system, there is broad agreement across party lines that we must maintain a commitment to support affordable housing for working families, including funds for low-income rental initiatives.
  • We need a common securitization platform to increase access for a diverse set of private investors. Currently Fannie Mae, Freddie Mac, and the plethora of private issuers have their own guidelines. A common platform will make this new system user-friendly. In fact, the federal Housing Finance Agency is already working towards a common securitization platform including a commitment to a single security for both Fannie and Freddie.

Now we must "get there" before inertia gains even more momentum. The new Congress must recommit itself to drafting legislation that will transform housing finance in the twenty-first century. Even the leaders of Fannie and Freddie have decried the state of limbo in which the enterprises find themselves and want to find a way out. In the world of housing finance (as in Wonderland), we have no Google Maps. Instead, we must first answer some questions.

In a revamped $5 trillion single-family mortgage market, we want private capital. How much will we need to assume the "first loss" position and protect taxpayers? Is it $500 billion, reflecting a 10 percent capital buffer? Or will $30 billion (5 percent) suffice? Pick a figure. We cannot proceed without one.

Who will provide the private capital? Institutional investors? Pension funds? Central banks? What form should this private capital take: Should it enter the system through capital markets structures, private mortgage insurance, lender cooperatives or a combination?

How costly will reform be? Private capital will charge for its risk-taking. The government entity (whatever its title) will also charge an unsubsidized fee to cover the catastrophic risk it assumes. What impact will these fees have? Understandably, with the best economic models, we will be unable to predict with certainty the impact, but we must try.

How will this new system provide affordable mortgages for creditworthy working families—not as a special "niche" product for a subset of low-income borrowers, but integrated into the system?

How do we ensure that the government-guaranteed secondary market is open on full and equal terms to lenders of all types, including community banks and housing finance agencies?

We must not capitulate to the status quo and hold our breath, dreading the next bubble. We must continue to chart reform. If the Congress remains unable to advance the agenda, the Enterprises will remain mired in conservatorship risking the loss of key managers and further deferred maintenance on the technological infrastructure needed to attract global capital.

It is time for Congress to finish the job and pass bipartisan legislation that can undergird the nation's housing finance system without placing undue risk on the taxpayer.

Republished with permission. This article first appeared in HBS Working Knowledge on November 12, 2014.