Consulting Corner

A New Foundation for Housing Finance
By Andrew Davidson

Critics of change say "if it ain't broke don't fix it." They repeat their mantra, even as water drips from the ceiling. But when the roof of your home leaks, you repair it; and as your family grows, you dream of a new home. The events of the past year in housing finance, including excessive portfolio risk at Fannie Mae and the accounting turmoil at Freddie Mac, are clear signs that there is a leak in the roof that needs fixing. It may even be time to build a bigger better home for housing finance.

There has been much discussion of remedies and changes. Yet much of these discussions are tactical, without consideration of broader objectives. Changes to the housing finance system should not be taken lightly-as an overreaction to current events or as the result of a philosophical fad. Rather, any changes should be well thought out and implemented in a manner that preserves the best of the current system while providing the flexibility for the system to better respond to growth and change.

If the system is to be changed, it is important to identify those ingredients that are essential for the continued success of the housing finance system. Specific proposals for change can then be measured against those principles. Public purpose, competition, capital adequacy and effective regulation are essential cornerstones for building a better home for the housing finance system.

Public purpose. The purpose of the housing government sponsored enterprises (GSEs) is to ensure the effective operation of the housing finance market. Currently, they do this by guaranteeing mortgage-backed securities held by investors and by investing themselves in mortgages and mortgage-backed securities. In this way they may make funds for mortgages available at lower cost and on a more consistent basis.

The federal sponsorship of housing finance is also intended to more generally facilitate home ownership. In this regard, the efforts of the GSEs housing finance entities must extend beyond lowering interest rates through their secondary market activities. Research has shown that marginally lower interest rates, especially when the lower rates apply to all borrowers, do little or nothing to enhance homeownership. While the GSEs should be supporting the low and moderate-income >>>