Stanford Kurland is founder, chairman and chief executive of PennyMac Financial Services.
Stanford Kurland is founder, chairman and chief executive of PennyMac Financial Services.

Housing finance reform has failed to make much progress since the financial crisis. In fact, if another downturn were to hit our housing market as it structured today, the American taxpayer would be directly and legally on the hook for every single one of the $6 trillion to which the federal government is directly exposed through Fannie Mae, Freddie Mac and government loan programs.

Clearly, the United States needs a system in which credit risk is better dispersed. If risk is appropriately priced and incentives are properly aligned, mortgage credit can remain widely available to would-be homebuyers while taxpayers are insulated from bearing losses. While there is much disagreement about the best way to transition to a new model, there is general consensus on one proposition: we must bring in private capital as a key component of long-term reform.

To that end, Fannie Mae and Freddie Mac have developed new risk-sharing bonds that shed small slices of credit risk on loans they securitize, shifting incremental risk away from the government and onto the investment community. The GSEs should be commended.

But those structures have important limitations. Many of the bonds sold so far trade like government-backed debt in a slightly different form. The taxpayer remains on the hook for actual losses on loans delivered to Fannie and Freddie. These structures also leave decision-making power on how and when to shed the risk with the two institutions.

The good news is that there is a way to truly privatize mortgage risk, keep interest rates low, align incentives and protect the taxpayers. Fortunately, this solution may be closer at hand than many people realize.

A new concept called “front-end credit risk transfer” is emerging in which the private sector prices and absorbs the majority of housing credit risk. This model has been met with some success already. It can and should be a bridge to long-term reform. With Congress again this summer looking to use the guarantee fees charged by Fannie Mae and Freddie Mac to pay for things unrelated to housing credit risk, it can’t come soon enough.

In this risk transfer structure, a privately financed mortgage company with public shareholders leverages the GSE infrastructure to securitize loans. Market participants call the deal “front-end” credit risk transfer because the capital necessary to absorb all but extreme catastrophic losses is set aside by the private company in a separate account at the same time that the loans are delivered to a GSE for securitization. Under all but the most dire scenarios for loan losses, the private company bears the credit risk on these loans instead of handing off that risk to the taxpayer.

In order to achieve scale, pricing on these credit risk transfers must be at a level sufficient to earn reasonable returns for shareholders in mortgage firms and real estate investment trusts. But that does not mean that mortgage rates must go up. Interest rates stay low because front-end credit risk transfers use the existing GSE securitization system, tapping into the robust demand for agency mortgage-backed securities from interest rate investors.

If this structure had been widely used at the time of the 2008 crisis, it could have helped prevent — or at least materially reduce — the terrible repercussions of the housing market crash.

This model should form the basis for America’s future mortgage credit system. Not only does it insulate taxpayers, it aligns market incentives. Investors in private securities and loan servicers have every stake in the success of the loan and the homeowner because they know they will bear the bulk of the losses. The model would also allow the functions that Fannie and Freddie currently perform to eventually be transitioned to any of the utilities or new private companies envisioned in recent legislative proposals.

We have the opportunity to create a strong housing market for the 21st century. Seven years after the financial crisis, it’s time to get moving. If policymakers require the largest actors in the mortgage market to do more front-end credit risk transfers, we can achieve comprehensive housing finance reform and finally remove the housing market’s dependence on taxpayer support.

Stanford Kurland is founder, chairman and chief executive of PennyMac Financial Services, which operates a national mortgage lender and servicer, and its affiliate PennyMac Mortgage Investment Trust.

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