homeowner, the housing finance system would also be well served by eliminating artificial distinctions between loans of different sizes and credit quality.

Competition. One reason for the early successes of Fannie Mae and Freddie Mac was that there were two similar organizations striving to serve different sectors of a very large market. Fannie Mae largely served the mortgage banking community, while Freddie Mac served the Savings and Loans. Each sought innovative ways to best serve mortgage originators and investors. With the growth of the mortgage market and the GSEs' respective shares of it, two firms are not sufficient to provide robust competition. Increasing the number of players in the mortgage secondary market would enhance competition and serve to decrease the systemic risk created by the current concentration of mortgage holdings in the two GSEs.

To spur competition, the government should create new housing charters to replace the current GSE charters. Determining the optimal number of charters will take some analysis. There should be a sufficient number of institutions operating under the new charter to ensure competition. At the same time, the number should be kept small enough to avoid diluting the benefits of the charter. Probably somewhere between 5 and 10 federal housing finance entities would be appropriate.

The new charter could be auctioned to new and existing players. Yes, even Fannie Mae and Freddie Mac would pay for the right to have an advantaged position in the market. The Federal Home Loan Bank system would also be required to purchase this new charter if they wish to engage in MBS activities. (Ideally the Federal Home Loan Bank system should be consolidated, but that is a story for another day)

Under the new charter, housing finance entities could be part of financial institutions that engage in other activities. With this new flexibility, there must be clear limits on charter benefits, including limits on the size and scope of their activities in the mortgage market. Limiting the size of their mortgage portfolios would help reduce systemic risk, while limiting the amount of their mortgage security guarantees would ensure competition. It would also be appropriate to limit the market share of the servicing portfolio and origination volume of firms utilizing the new federal housing finance charter.

Transition from the current two-participant market to a more competitive market will require that the Fannie Mae and Freddie Mac face limits on their current activities. In exchange for limitations on their current activities, they would be given the opportunity to expand into other financial services and activities through a holding company structure. >>>