e21 Contributor Phillip Swagel Testifies Before the Committee on Financial Services
Testimony of Phillip L. Swagel
Before the Committee on Financial Services U.S. House of Representatives
“The Future of Housing Finance: A Review of Proposals to Address Market Structure and Transition”
Wednesday, September 29, 2010
Chairman Frank, Ranking Member Bachus, and Members of the Committee, thank you for the opportunity to testify on the future of housing finance. I am a visiting professor at the McDonough School of Business at Georgetown University and a non-resident scholar at the American Enterprise Institute. I was previously Assistant Secretary for Economic Policy at the Treasury Department from December 2006 to January 2009.
Donald Marron Jr. and I have put forward a specific plan for reform of the government sponsored enterprises (GSEs) that ensures the availability of mortgage financing while focusing the government on its relative strengths of providing a backstop against financial catastrophes and directing appropriate subsidies for affordable housing (the plan is available on the Economics21.org website at https://economics21.org/commentary/whither-fannie-and-freddie-proposal-re...). I will use a discussion of our proposal to address the questions raised by the committee for this hearing, including comments on alternative reform approaches and transition issues.
A plan for GSE reform: Summary
Our plan would have the federal government sell a secondary guarantee to firms that securitize mortgage-backed securities (MBS) made up of high-quality conforming loans. Fannie Mae and Freddie Mac would be privatized and focus on securitization, and would compete with other private firms such as banks that could buy the federal MBS backstop on the same terms. The government would not guarantee any particular firm—shareholders would be wiped out before the government insurance pays off in the event of a failure. Allowing new firms to purchase the government guarantee and compete with Fannie and Freddie on conforming MBS is crucial. The history of government insurance programs is that the coverage is inevitably underpriced and this gives rise to a subsidy. Competition for Fannie and Freddie will help drive the subsidy to families looking to buy a home or refinance their mortgage rather than having the subsidy accrue to shareholders and management. Moreover, with additional firms providing MBS securitization, a GSE could fail without it being a catastrophic event—the activities of other firms would ensure the continued flow of funding to housing.
The existing GSE portfolios would be wound down under the plan to remove the need for massive GSE borrowing that put the financial system at risk and necessitated the government takeover in September 2008. To preserve important features of the current system, the Securities and Exchange Commission (SEC) would provide enough regulatory flexibility to allow for the use of the TBA (“to be announced”) structure now used in the securitization of conforming MBS. Part of the insurance premiums charged by the federal government would go to funding affordable housing activities, but these would be carried out by the government and subject to normal appropriations procedures. The balance of premiums would go into the Treasury general fund and offset over time the expected costs of the government guarantee. Fannie and Freddie and other firms engaged in securitization would not be subject to special housing goals as part of their securitization activities, though banks would remain subject to provisions such as the Community Reinvestment Act.
The choices embedded in this plan are discussed in more detail below, including the pros and cons of this approach and of alternatives. This proposal eliminates the worst aspects of the previous system—uncompensated taxpayer risk, systemic threats to the financial system, lack of transparency, and undeserved duopoly profits. It maintains an effective mortgage market for Americans looking to buy or refinance a home while putting the government role in plain sight and providing a funding source to support affordable housing activities.
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