A white paper released yesterday by the Milken Institute said the Federal government should allow other mortgage finance-related companies to compete with Fannie Mae and Freddie Mac on a level playing field. The GSEs should also move back into private hands, the paper argued.   

Private capital would then stand in front of a secondary government guaranty on MBS, according to the white paper titled Reform of the GSEs and Housing Finance. The paper was written by Milken Institute Senior Fellow Phillip Swagel, a professor at the University of Maryland School of Public Policy and former senior official at the U.S. Treasury during the financial crisis.

"Competition will best drive innovation and ensure that the benefits of government involvement in housing go to homebuyers in the form of lower interest rates," Swagel wrote.

The white paper's proposal in is meant to ensure that Americans have access to mortgages in all market conditions. This is accomplished while making private capital the dominant funding source for housing and protecting taxpayers from a repeat of the $150 billion rescue of Fannie Mae and Freddie Mac during the financial crisis.

"While government guarantees of mortgages are needed for the foreseeable future to ensure that Americans can obtain mortgages at reasonable rates, housing finance reform must be done in a way that protects taxpayers against future bailouts," Swagel said.

Reform likely will lead to higher mortgage interest rates. According to the paper, this is not a problem to be avoided, but a consequence of protecting taxpayers by putting private capital ahead of them. A secondary government backstop is still important, however, because without it interest rates could rise by hundreds of basis points, and hundreds of thousands of homes would go undeveloped or unsold.

However, standardizing the instruments involved in securitization to create a common form of MBS would be a helpful step in the transition to a better housing finance system. Such a step would immediately improve liquidity and lower interest rates today. It will also ensure that this liquidity continues as new firms enter the securitization in the future.  

The alternative to reform is for Fannie Mae and Freddie Mac to remain in conservatorship and for the government to play a dominant role in housing finance.

"This would be the worst outcome for the U.S. financial system, the overall economy and future homeowners, who would not benefit from the innovation and competition that only the private sector can bring about," Swagel wrote. "The longer the GSEs remain in conservatorship, the more likely it becomes that they remain there forever — and that taxpayers take on all the risks of housing finance. Now is the time to move forward with reform."

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