All my adult life, I’ve tried to be both a size four and a free-spirited diner at the world’s finest restaurants.  Sadly, something had to give – a fact of life that also applies to Senate Banking’s draft legislation to redesign the U.S. housing-finance system.  The draft tries very hard to accommodate all the needs of private-sector guarantors that would step in ahead of the government and at the same time bullet-proof the government since it would still take the fall if private guarantors can’t ante up.  For good measure, the bill also wants to ensure national access to thirty-year fixed-rate mortgages, provide generously for affordable housing, and make Fannie and Freddie disappear without a fuss.  But just as I can’t be a size four and a gourmand, Senate Banking also can’t have all it wants all the time.  Decades of political-economy research demonstrates that equity – the public good – and efficiency – the wellspring of private profit – cannot be fully realized at the same time.  Fannie and Freddie were experiments in maximizing private profit at the expense of public good and public housing projects are the reverse.  Unless the Senate bill makes tough choices, its results will pave the way for our next housing debacle.

Let me start with one proposition in the bill that’s among the biggest have-your-cake-and-eat-it-too conundrums. The legislation is extra-paranoid about accusations that anything in it might benefit a very big bank so it is at pains not only to make the private-guarantor business model as inefficient as possible, but also to stipulate that anyone rash enough to try to start one would come under rules akin to those now applicable to U.S. GSIBs.  A key blank is left for the leverage-capital requirement and the risk-based rules appear to be left wholly to the regulator, but the scope of all the standards – some directly modeled on the Fed’s CCAR requirements – make it clear that all but another captive regulator will match the Fed one for one. 

GSIBs have enough trouble making investors happy under all of these rules, but at least they have a business model with considerable internal diversification and the ability to dump a business line if the rules make it unprofitable. GSIBs have preserved their business model – sort of anyway – in the face of all of these rules, but among the businesses in the dumpster are residential mortgages.  You also don’t see GSIBs as GSE counterparties in most of the credit-risk transfers the GSEs now deploy to reduce taxpayer risk (maybe).  The GSIBs’ required numbers just don’t add up for mortgage risk and it’s hard to see how they could for anyone else.

Even if it’s possible over time to bring private guarantors up to GSIB snuff, this is a doomed exercise for start-up Enterprises.  The Obama Administration estimated that it would take Fannie and Freddie about twenty years to meet bank-capital standards and I suspect they were looking at the easier ones, not the onerous GSIB requirements. 

The private-profit/public-good problem gets still more intractable when one considers all the fees the bill requires anyone fool enough to start a guarantor would have to pay.  These fees are for the pleasure of stepping in ahead of the government and for funding a menu of new affordable-housing programs.  It makes sense to charge companies for the privilege of a federal stamp and perhaps also to take a little off the top for affordable housing.  But you can’t use private entities as de facto substitutes for public expenditures and expect to have viable private enterprises – the cognitive dissonance is too great.

FHFA’s proposal to reform the GSEs recognized this inherent conflict and proposed that the GSE successors be public utilities.  This is the time honored U.S. approach to meeting public needs – e.g., reliable electricity – without sacrificing private-profit objectives.  Utilities are regulated to a fare-thee-well to ensure they maintain public service, utility charters are also monopolies granted rates of return by state and local utility commissions.  These rates of return aren’t anything Wall Street wants, but they have long satisfied risk-averse investors – the “widows-and-orphans” part of the market that still needs safe and sound investments.  The utility model is far from perfect, but the lights generally stay on.

If we want the penalty-free pre-payable thirty-year, fixed-rate mortgage to continue as a national prerogative of households across the entire income spectrum, a new commitment to affordable housing, lots of private capital ahead of the taxpayer, and safety-and soundness safeguards to prevent a Fannie/Freddie rerun, then the utility model and maybe a couple of lender cooperatives are the only possible option other than a government corporation.  The utility charters manage the trade-offs between equity and efficiency in transparent ways with demonstrable track records.  Like them, any entity backed by the explicit full faith and credit of the U.S. Government established with private-profit  features  must ensure that public equity is enhanced by added private efficiency, not put at risk or undermined by all the inherent conflicts that brought down Fannie and Freddie and threaten a critical reform effort.