Inside Mortgage Finance

GSE Policy Solution Cost May Prove Central

The fates of Fannie Mae, Freddie Mac and the Federal Home Loan Banks and the future of housing finance in the United States will probably come down to the overall price of the final package of reforms, according to some top policy analysts. “We continue to believe that fiscal impact will be the determining criterion for the Obama administration’s package,” said public policy experts at Federal Financial Analytics, a private thinktank in Washington, DC, in a review late last month of the Congressional Budget Office’s report outlining the administration’s key choices for restructuring Fannie and Freddie. “If it can figure out a way to score a hybrid model with a catastrophic-risk guarantee as a net revenue source, it will be the winner,” they added. “If, however, opponents within the administration – who believe that no guarantee can be right-priced – win out, then pure privatization will emerge as the default option because a government takeover costs too much too soon.” Karen Shaw Petrou, co-founder and managing partner at FFA, re-iterated the view that “the over-riding consideration for the reform plan is going to be fiscal policy. Any plan that costs a lot of money is going to be D.O.A,” she told Inside The GSEs. “Now, there are ways to structure reform initiatives that are either revenue-neutral or even ostensibly revenue raisers, and I think that is a driving consideration from the Obama administration and the GOP perspective as well.” For instance, “I think you will see the catastrophic risk guarantee concept proposed as a revenue raiser, much as federal deposit insurance is, from a budgetary point of view, a revenue source,” Petrou said. Of course, pricing is a critical issue. “In this country, we’ve lived for 70-plus years with federal deposit insurance that’s been horrendously mispriced,” she added. “My guess is that we will do more of the same at least initially for the GSE successors.” The catastrophe risk guarantee pricing “does not need to be „right? or as right as it would ideally need to be if you had a really robust layer of private capital in front of it,” Petrou continued. “That would minimize the perverse incentive issues over a mispriced federal guarantee, because even if it’s completely mispriced, any associated losses would be relatively theoretical because it’s frontloaded; that is, whether it’s private mortgage insurance or issuer capital, somebody else takes the fall anyway.” This is a concept that the Federal Reserve, including chairman Ben Bernanke, has taken up and is “advocating rather vigorously, mostly behind closed doors,” she added.