October 9, 2014

The phase-out of Fannie Mae and Freddie Mac, which have now been in conservatorship for 6 years, is on indefinite hold. Terminating them without an effective replacement would devastate the market, and no effective replacement is in sight. The one proposed by the Senate Banking Committee, which I looked at last April, would not do it. It is time to rethink the premise.  

Why Are We Determined to Ax the Agencies?

Fannie and Freddie over the years have accumulated enormous intellectual capital that is embedded in well-honed secondary market systems and processes. Scraping the agencies would destroy much or all of this capital – to what end? True, their structures of governance, combining private shareholding with politically-determined operating targets, were unsound, but that can be fixed. In conservatorship they are entirely under government control, and they could remain so as Federal agencies. 

The true motivation for axing the agencies seems to be the need for political catharsis. When Congress refuses to provide an agency with the tools it needs to meet its objectives, or imposes conflicting objectives, and failure results, Congress needs to ax the agency. It did that to the Federal Home Loan Bank System, which was tarred by the savings and loan crisis that the System was powerless to prevent. That agency could be terminated because its functions could be shifted to other agencies, but Congress has not been able to terminate Fannie and Freddie without assuming responsibility for a market collapse. Hopefully, the passage of time is moderating the urge.  

The Case For Retaining Fannie and Freddie 

The case for retaining the agencies goes beyond their role in maintaining secondary markets. That role positions them to make substantial improvements in the primary market. The potential has always been there, but lender organizations have been adamantly opposed to any intrusion by the agencies into what the lenders view as their turf. Much of this opposition is based on a fear that the agencies will lend directly to borrowers, which I agree would be a terrible idea. None of the proposals made below involve direct lending by the agencies.

The existing primary market works poorly for borrowers.

·        They often make bad decisions because of the complexity of the instrument and the process, and the lack of reliable and disinterested support.

·        They often do not get the best deal available in the market because shopping effectively is so difficult.

·        The settlement costs they must pay are excessively high because of perverse market incentives.

Fannie and Freddie could deal effectively with all of these problems.

Why Not the Consumer Financial Protection Bureau (CFPB)?

It might appear that if any Federal agency is entrusted with responsibility to improve the primary mortgage market, it ought to be CFPB, because that agency is almost entirely focused on consumers in primary markets. However, it is already evident from its history to date that CFPB sees its mission as protecting borrowers by enforcing existing laws, and has no interest in making markets work better.

A good illustration is the work that CFPB did in revamping the mortgage disclosure documents, responsibility for which it took over from the Federal Reserve and HUD. The new disclosures are clearly better, in both clarity and aesthetics, yet they don’t help borrowers shop for the best price, or protect them from unwarranted changes in price during the processing period, any better than the disclosures they replaced. When I pointed this out to CFPB, it was clear that the message was not one they cared to hear.

How Fannie and Freddie Could Improve the Market

The core of the initiative would be an internet-based network on which certified lenders post their underwriting requirements and prices, where borrowers can go to obtain mortgages. Borrowers are benefitted by the information available to them on the network, and by the certification requirements imposed on participating lenders by the agency.  Both Fannie and Freddie would have networks and would compete to see which could draw the most borrowers. Here is a partial list of network features of value to borrowers.

1.     An easy way of determining whether the borrower qualifies, and if not, what is required.

2.     An easy way to determine which type of mortgage would cost the least over the borrower’s expected period in the house.

3.     An easy way to find the lender offering the best deal on the preferred mortgage, and to monitor that lender’s price until it is locked.

4.     Acceptance by all network lenders of one appraisal ordered by the borrower from an appraiser certified by the agency.

5.     Elimination of third party settlement costs, with all necessary costs embedded in the interest rate and lender fees.