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Home | Headlines | Back to Basics: 4 Ways to Transform the GSEs
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Back to Basics: 4 Ways to Transform the GSEs

DSN-freddiefannie-620x330Fannie Mae and Freddie Mac have been under conservatorship for almost eight years following a massive taxpayer-funded bailout. While many in the industry have called for a GSE reform on numerous occasions over the years, the future of the conservatorship remains uncertain.

Andrew Davidson, President of Andrew Davidson & Co., Inc., said in an essay published by the Urban Institute that a realistic approach to GSE reform would be to strip the GSEs down to the functions that are essential to promote standardization, liquidity, and access to credit, and adopt the best governance structures for those functions using these four methods.

Davidson says the delay in the GSE reform can be attributed to "misinformation about the role the GSEs played in the financial crisis and flawed ideas about the economics of mortgage-backed securities (MBS). In particular, critics of the GSEs have suggested that the GSEs and their affordable housing goals were the primary cause of the financial crisis and that the mortgage market could function without a government guarantee."

"Instead of shutting down the GSEs, eliminating the guarantee, or creating new entities, a realistic approach to GSE reform would be to strip the GSEs down to the functions that are essential to promote standardization, liquidity, and access to credit, and adopt the best governance structures for those functions," Davidson said. "This can be achieved in four steps: streamline, share risk, wrap, and mutualize. While some of these actions could be taken by the Federal Housing Finance Agency (FHFA) and the administration, the second, third, and fourth steps would require congressional action to fully implement."

Davidson identified four steps to approach GSE reform:

Streamline 

The GSEs should only perform functions related to their guarantee and securitization businesses. Their retained portfolio business should be substantially reduced or eliminated. This is already in progress. (Without having GSEs hold MBS, there could be greater volatility in pricing mortgages. This impact is currently mitigated by the large holdings of MBS by the Federal Reserve.)

Share Risk

The GSEs have demonstrated over the last two years that they can “reinsure” a significant portion of their credit risk into the market through several risk-sharing approaches, reducing taxpayer risk and the concentration of credit risk in the economy. For example, our analysis shows that Freddie Mac has shed approximately two-thirds of the risk on its target loans in its 2014 book of business. To continue this process, it is important to allow for the expansion of the investor base for credit risk transfer (CRT) products.

Wrap

The GSE MBS should receive an explicit government wrap like Government National Mortgage Association securities and should be closely regulated. In exchange for the government guarantee, the GSEs would pay a fee to the government that would defray the potential cost of the guarantee and fund affordable housing or other national housing goals.

Mutualize

Mutual ownership of the GSEs by mortgage originators offers the opportunity to align incentives and protect taxpayers from future losses while limiting the incentives to siphon the benefits of government guarantees to private shareholders.

About Author: Xhevrije West

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Xhevrije West is a talented writer and editor based in Dallas, Texas. She has worked for a number of publications including The Syracuse New Times, Dallas Flow Magazine, and Bellwethr Magazine. She completed her Bachelors at Alcorn State University and went on to complete her Masters at Syracuse University.
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