Fannie and Freddie

There is renewed discussion about what to do with Fannie and Freddie. In today's NYTimes Andrew Sorkin channels Barney Frank to explain why reform will be difficult.

More important, shutting down Fannie and Freddie and having the private market step in, as politically popular a sound-bite as that may be, is economically unfeasible. For better or worse, Fannie, Freddie and Ginnie Mae were behind 98 percent of all mortgages in this country so far this year, according to the Mortgage Service News. Pulling the rug out from under them would be pulling the rug from under the entire housing market as it continues to struggle.

The GSE's may have repackaged 98 percent of all mortgages in the country, but they did not finance them. That still came from savers. The GSE's, after all, still need funds just to survive. The real question is why the private market cannot package and sell bundles of mortgages in the absence of the GSEs? We know they did this before the financial crisis.

Presumably, the private markets are less willing now to refinance mortgages with very low down payments. They probably have learned from their mistakes. The pressure to keep the GSE's derives from the desire to continue to make risky loans that the private markets won't make.

So the question is who did not learn from the crisis, private markets or the government?

Mortgage Finance

This article by John Krainer of the San Francisco Fed has lots of information about the evolution of mortgage finance. This is important for thinking about the financial crisis of course. This is especially relevant for thinking about the relative importance of Government Sponsored Enterprises (GSE's) like Fannie Mae and Freddie Mac versus the non-agency securitizers. We can see, for example, that as the housing bubble proceeded the share of mortgages supplied by the GSE's declined:


We can also see that the non-agency lenders were more highly represented in the more risky types of mortgages at the height of the boom. For 2006 we have this picture:


Thus:

Compared with mortgages purchased by the GSEs, non-agency securitizations were much more likely to involve adjustable-rate mortgages, including option ARMs, to be rated as subprime, and to have less-than-full documentation of borrower income and assets. The median FICO credit score for the non-agency securitizations was about 30 points lower than for the mortgages held or guaranteed by Fannie Mae or Freddie Mac and much closer to the credit scores typically associated with loans guaranteed by Ginnie Mae.

These pictures are not consistent with the view that the housing bubble was the fault of the GSE's alone. Deteriorating standards seemed to accelerate as the GSE share fell.

Debt Reduction

John Geanakoplos and Susan Koniak have a nice op-ed in the New York Times that proposes a solution to the mortgage crisis. The key point is to focus on reducing principal rather than interest rates on mortgages where the borrower is underwater. Some great pictures in the article on how default rates are related to the extent a borrower is underwater.

The key point, I think, is that when you have a borrower who is insolvent you solve the problem with renegotiating the principal, not reducing the interest cost. The latter may deal with liquidity, but not insolvency. For the latter you need to make the borrower have an incentive to pay off the loan. That is where principal reduction comes in. They also show what their solution is cheaper than those considered by the Obama administration.