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View related content: Housing Finance
The Treasury Department convened a conference on the future of housing finance in August 2010. These are the remarks of Alex J. Pollock.
SEC. GEITHNER: Alex.
MR. POLLOCK: Many thanks to the Treasury and to HUD for inviting me here. In my two minutes, I’m going to try to make three points with one quick addendum.
Point one, the housing finance system of the future needs to have countercyclical factors built into it, particularly (a) countercyclical loan?to?value ratios, which move in the opposite direction as inflating house prices in a boom; and (b) much bigger loan loss reserves in good times to avoid the illusory profits which feed booms and bubbles.
Second, we need a private secondary market for the bulk of mortgage loans. The financial system of the future should have withdrawn from it a large part of the subsidization and distortion of the market caused by the activity of the GSEs. This private secondary market should handle the loans for the middle class and the upper middle class mortgages, which are the vast majority of the market. Such a private market could include the covered bonds; it has to have private market rates, spreads, and risk evaluations and avoid the subsidies which drive up house prices and make houses less affordable.
Third, ultimately, we should have no GSEs. Fannie and Freddie should no longer be GSEs. You can either, in my view, be a private company or a government agency–one or the other, but not both. I think almost everyone now agrees with this, but which is right, a private company or a government agency? My answer is, both are right.
Part of Fannie and Freddie should turn into a private company, the part which is actually a business. Part of it should turn into a full?fledged government agency, that part which is a government operation providing subsidies and nonmarket transactions; that should simply be merged into the structures of the Department of Housing and Urban Development subject to the normal government disciplines of appropriations and oversight.
There unfortunately has to be a third part, which is the liquidating trust or “bad bank” to run off the remaining government?guaranteed debt with a significant loss, of course, to the taxpayers. This could be legally modeled on the structures used in the privatization of Sallie Mae, I think quite successfully. I call this the “Julius Caesar strategy” because like Gaul in Caesar’s time, we divide Fannie and Freddie into three parts.
My addendum is that if, counter to my recommendations, the GSE form does survive, then we must make sure that the double leveraging of GSEs through the banking system is stopped. Banks had special regulatory encouragements to own the preferred stock, debt and MBS of Fannie and Freddie. All of this ran up the leverage, the real leverage of the system viewed as a whole. Remember that the biggest fault of the system was excessive leverage, and GSEs were key to excessive leverage. So we need to eliminate this ability to double?leverage the system by using the banks to finance the GSEs, should the GSE form somehow survive.
SEC. GEITHNER: Thank you, Alex.
Alex Pollock is a resident fellow at AEI.
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