Richard M. Kovacevich is the retired Chairman & CEO of Wells Fargo. William M. Isaac is Global Head of Financial Institutions at FTI Consulting and former Chairman of the FDIC. The views expressed are their own.
The recession of 2008, precipitated by the collapse of the subprime mortgage bubble, may be officially over, but economic growth remains anemic and is producing virtually no job growth. We must stimulate the moribund housing markets. Yet in the past three years, there has been no progress on the housing front, and Washington policymakers seem bereft of ideas for turning things around.
They argue this will eventually lead to getting the government out of the mortgage business.
It's not clear how increasing fees charged by Fannie and Freddie will encourage the government to wind down these agencies. Moreover, raising mortgage fees in the midst of the worst housing slump since the Great Depression will not stimulate housing or job creation. We need a clear path for eliminating Fannie and Freddie over time.
Subprime mortgages have existed for decades. But they were a small percentage of the mortgage market (well under 10%), until Fannie and Freddie reduced credit standards to increase market share and meet low-income and minority home ownership targets mandated by Congress. By 2007, nearly 50% of all mortgages that originated in the U.S. were subprime, with Fannie, Freddie and other agencies guaranteeing about 70%.
Without these government guarantees, the subprime bubble and the resulting financial crisis would never have happened. Bank regulators and industry experts warned Congress for decades about Fannie and Freddie and their increasingly large and risky portfolios.
Because Congress failed to act, nearly the entire developed world is suffering from the mortgage-induced recession. Taxpayers are on the hook for hundreds of billions of dollars of losses at Fannie and Freddie -- dwarfing the losses from banks, Wall Street, auto companies, insurance companies and all other bailouts combined.
Steps to Mortgage Reform
We don't understand why reform of Freddie and Fannie is taking so long and what all the angst is about. The solution is straightforward: The public/private hybrid of Fannie and Freddie should be abolished, their existing business sold or liquidated, and the mortgage market privatized.
This can be done in an orderly way in a few easy steps.
Fannie's and Freddie's existing portfolio of mortgages should be sold at a rate of about $75 billion a year until it reaches zero.
The current $625,000 size limit on new mortgages guaranteed by Fannie and Freddie should be reduced by $100,000 per year, so that Fannie and Freddie would be out of the guarantee business within six years.
The liability for any outstanding guarantees would be managed by the current government conservatorship of Fannie and Freddie until they run off or are sold.
If the government still wants to be in the mortgage business for low-income families or minorities, it should be on budget and transparent. There already exists a government organization to do this -- the Federal Housing Authority.
Some say this would put at risk the American dream of home ownership. We disagree. The United States is the only major country in the world where the government is heavily involved in the mortgage market. Yet, home ownership percentage in the United States is only slightly higher (a percent or two) than most other developed countries, while countries like Canada have higher percentages than the U.S.
Some speculate that without Fannie and Freddie, mortgage rates would skyrocket and the 30-year, fixed-rate mortgage would be a thing of the past. We disagree. Non-conventional or "jumbo" 30-year mortgages not guaranteed by Fannie and Freddie have existed for decades.
In the decade preceding the financial crisis, the interest rate on these jumbo non-conventional mortgages averaged just .25% higher than similar guaranteed mortgages, a difference of a little over $40 a month on a $200,000 mortgage. Shouldn't Americans, like homeowners throughout the world, pay a tax-deductible $40 or so extra per month so taxpayers aren't on the hook for hundreds of billions to bail out Fannie and Freddie?
It's clear that we need to abolish the public/private mortgage model as represented by Fannie and Freddie. The U.S. mortgage market should be privatized, as it is in other developed countries.
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