After financial reform, GSEs should be the next sector dealt with, said Federal Deposit Insurance Corp. (FDIC) Chair Sheila Bair at the University of Pennsylvania today. Text of her speech follows:
Since the 1930s, the federal government has played a major role in facilitating the development of a strong secondary market for mortgage loans. Through the Federal Housing Administration (FHA) and the government-sponsored enterprises, the government has directly or indirectly provided credit guarantees that have promoted the origination and securitization of mortgage loans that conform to certain standards and size limits.
While these programs have long served to lower the cost of mortgage credit to broad classes of homeowners, they have become an even more essential source of mortgage credit during the recent crisis. In 2009, the FHA and the GSEs accounted for 95% of total U.S. mortgage originations.
To the extent that the government wishes to promote homeownership and stability in the availability of mortgage finance, some level of ongoing government involvement is certainly justified. However, a lesson of the mortgage crisis is that any such program must be much more definitive about where the financial obligation of taxpayers begins and ends.
For decades, the mortgage GSEs raised funds in global markets at preferred, near-government rates on the basis of their quasi-governmental status. For many years, this arrangement lowered the cost of mortgage credit to millions of homeowners without adding to the federal debt.
However, in the aftermath of the mortgage credit crisis and the conservatorship of Freddie Mac and Fannie Mae, the implicit backing of these entities is now an explicit cost. Federal subsidies for the GSEs in 2009 and 2010 are estimated at over $300 billion.
In banking, the implicit backing of large financial institutions under the doctrine of Too Big to Fail led to moral hazard and excessive risk taking. This is a problem that Congress is attempting to fix. In the wake of the financial crisis, the U.S. and other governments around the world are feeling the brunt of a wide range of "implicit liabilities" that are quickly becoming explicit obligations in times of financial distress.
Our future financial stability demands that we deal with these implicit liabilities head on, and limit the ability of private companies to take risks at the expense of the taxpayer. In the case of the mortgage GSEs, there are a variety of options for making some of their functions governmental while putting others in private hands. But what we cannot do is perpetuate their quasi-governmental status, which privatizes gains and socializes losses.
After the financial reform package becomes law, GSE reform should rise to the top of the agenda. The goal must be to clarify once and for all which functions should be governmental, and which are strictly subject to the discipline of the marketplace.
I've often spoken of the need, in the wake of the financial crisis, to restore balance to our economy and to our national economic policies. The mortgage crisis in many ways is the culmination of a decades-long process by which our national policies have distorted economic activity away from savings and toward consumption; away from investment in our industrial base and public infrastructure and toward housing; away from the real sectors of our economy and toward the financial sector.
No single policy is responsible for these distortions, and no one reform can restore balance to our economy. We need to look at national policies with a long-term view, and ask whether they will create the incentives that will lead to improved and sustainable standards of living for our citizens.
Homeownership is certainly a worthy national goal. But does it make sense for the federal government to subsidize homeownership in an amount three times greater than the subsidy to rental housing? In the end, these subsidies have helped to promote homeownership, but have failed to deliver long-term prosperity.
I am not advocating a specific proposal. I'm only pointing out that where homeownership was once regarded as a tool for building household wealth, in the crisis it has instead consumed the wealth of many households. Foreclosures continue to take place at a rate of about two-and-a-half million per year, and an estimated 11 million households owe more on their mortgage than their home is worth.
Now, much concern has been expressed in recent weeks that the financial reform legislation will hurt our economy by limiting the earnings capacity of the financial services industry. And if that means limiting the ability to expand private-sector profits by imposing risks on the public balance sheet, they may well be right. But let's put this in perspective.
Any potential harm to the industry's future earnings potential must be weighed against both the long-term increase we have seen in the financial sector's share of U.S. corporate profits and the widely-shared and long-lasting costs of the financial crisis. Whereas the financial sector claimed less than 15 percent of total U.S. corporate profits in the 1950s and 1960s, its share grew to 25 percent in the 1990s and 34 percent in the most recent decade through 2008.
The financial crisis and the Great Recession it spawned threw 8 million people out of work, reduced our GDP by about 3%, caused a huge increase in federal debt, and virtually wiped out the entire net income of FDIC-insured institutions for at least a two-year period.
We need to get back to a world where our financial sector supports the functioning of our economy, and not the other way around. And we need to fix what caused the crisis by reforming our mortgage lending and securitization practices. Only by getting back to basics in these most fundamental areas of our financial system can we begin to restore balance to our broader economy and confidence in our economic future.