Earlier this week, Judge Royce Lamberth handed some GSE shareholders a karate chop in the solar plexus, essentially telling them that litigation claiming the Treasury done stole their shareholder rights was DOA. The Wall Street Journal editorial on the decision said it succinctly: “Uncle Sugar’s blessing to the GSEs went far beyond their rescue.” After all, how could a company with no capital or liquidity post any profits at all if not for the de facto full-faith-and-credit taxpayer backstop behind each of the GSEs? However, the fact that the GSEs are de facto nationalized has much broader impact than just dooming this effort at self-privatization. It speaks to the more fundamental challenge of what to do with two companies that can’t live on their own on which the U.S. residential-finance system still so largely depends. My solution: recognize what the GSEs are now – mortgage utilities – define the scope of their future operations as such, and move on to a new mortgage-finance system in which government sponsorship is explicit, but limited.
One might opt for the full-on liquidation option that shrinks the GSEs into entities that could be made to disappear if it weren’t for the year-in, year-out inability of the private sector to compete with the GSEs and issue enough private-label securitizations (PLS) to give the GSEs a run for the money. Recognizing this, Treasury is considering calling in contractors to craft new representation-and-warrantee standards that might ease PLS into a standardized model akin to the contractual certainty that created the OTC-derivatives market. However, there’s one big difference: OTC derivatives never faced Uncle Sugar; PLS do.
I know of no way anyone can compete with the U.S. Government. Indeed, even if private companies could to any meaningful extent, a raft of new rules make PLS all but impossible unless 1) non-banks are able to persuade investors that their guarantee is as good as a USG one – scant odds; or 2) bank regulators roll back all the rules that now push big-bank originators to hold loans on portfolio, sell them to Ginnie Mae, or just give it all up and look for something else to do. There may be a few changes around the margin – slightly easier capital rules for the highest-quality, simplest PLS, for example – but any material rewrite of all the new impediments to big-bank PLS are here for the duration. Indeed, if anything, most of them will get only tougher.
So, where does this leave us? One could abandon the GSE model as FinServ Chairman Hensarling’s bill would have done and hope that a little bit of FHA and a whole lot of PLS will make up the difference, giving at least enough Americans in thirty-year, fixed-rate mortgages to keep afloat this critical economic sector. Whether this might work is moot – it won’t pass.
Nor, I think, will anything like the Johnson-Crapo bill designed to perpetuate thirty-year, fixed-rate mortgages for all in a to-be-announced market backed by the taxpayer that has a bit of up-front capital to cushion any blows. The new rules mean that non-banks would need to take this first-loss position – big banks are largely barred from it by all the new rules – making this a problematic solution even if it could pass this year, which it can’t.
The only possible course is to reckon with the reality that decades of humongous GSEs have created: millions of Americans want a GSE-style mortgage and, even if they could be persuaded to accept rental housing or other loan types, cadres of Realtors, homebuilders and other private interests will support the biggest federal role they can get. Big-bank regulation is increasingly moving to the utility model – that is, it recognizes the fact that no one loves big banks, but there are far too many ways in which markets and economies depend on them to leave them behind. Is this the right solution for big banks or the GSEs? In a perfect world, no. In the real world, for the GSEs, yes.
Now that the litigation has settled the odds for privatization very much against current shareholders, the life-support model for the GSEs that has governed their operations since 2008 cannot continue. The total absence of fixed-income market volatility masks how leveraged the GSEs are atop a still-fragile financial system. Maybe the GSEs will stand firm in a renewed flight to quality; maybe not, given all their own counterparty risk to the very largest banks. This is a systemic bet that grows riskier every day.
FHFA has a lot of authority to redesign the GSEs – indeed, it’s doing so with the common securitization platform. Now, it must also try its hand at creating a mortgage-guarantee utility, working within the boundaries of the GSEs’ charters to design a new-style government corporation that can seamlessly succeed to the current, hybrid GSE model and all its continuing risk.