There has been much discussion around the future of the GSEs. There are three models being floated around: a hybrid market with some GSE involvement; the GSEs becoming full federal agencies; or the privatization of the markets without any GSE involvement. However, there has been little focus on how a new infrastructure for housing finance will be built.

According to Laurie Goodman, senior managing director at Amherst Securities Group, creating and implementing an alternative to the current system will further restrict credit availability in the middle of a housing crisis. Goodman spoke at an American Enterprise Institute panel discussing the future of Fannie Mae and Freddie Mac. It is important to understand how important the government-supported agencies have been to the mortgage system.

Goodman said private-label mortgage securitizations and bank portfolio loans comprise only a portion of the market.

Losses that the GSEs have experienced resulted from two factors, Goodman noted. GSE portfolios now contain private-label securities and these agencies also failed to adequately risk-base price their guaranty book of business. "The GSEs were not sufficiently quick to raise prices in 2007, " Goodman said. "As the private label market shut down, this led to GSE guarantees on risk-layered loans without a commensurate revenue increase or capital reserves."

Fannie Mae's and Freddie Mac's share was about 25% in 2005, Goodman noted. "Initially when standards began to deteriorate, Fannie and Freddie held prices constant and the securities went to the private-label market," she said. "Then, in 2007, when the private-label market shut down, Fannie and Freddie held prices constant and took on a huge amount of these risk-layered loans."

However, since the crisis began the GSEs have tightened lending standards dramatically. According to Freddie Mac loan-level data information, low credit issuance - loans with an LTV greater that 80% and a FICO less than 700 - is now about 2% of total issuance. Goodman said it was 10% in 2006, increasing to 20% at the height of the crisis when Fannie and Freddie were gathering loans from the collapsed non-agency market.

The decrease to 2% , she said , is a result of new measures put in place at the agency level that require loan-level pricing and the rising number of loan-level pricing adjustments made.

Goodman argued that Fannie and Freddie have a functional infrastructure that should be employed as part of a hybrid solution. However, unlike the other hybrid models being discussed, Goodman believes that the government's role should be as an intermediary. She thinks that a hybrid model calls for a TBA market with an explicit government guaranty where delinquent loans would be re-pooled into non-TBA-eligible prefixes after a given period. Servicing advances of principal and interest would not be required beyond this point.

"The key feature is that risk would be priced by the private market, and the government would stand as a credit intermediary and wouldn't be pricing the risk," Goodman said.

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