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Op-Ed: To reform the housing market, get rid of these two bloated behemoths

  • Fannie Mae and Freddie Mac are the real culprits at the heart of the last financial crisis.
  • Finally, a bipartisan effort is underway to reform the too-big-to-fail home financing industry institutions.
  • Here's why Fannie and Freddie need to go.

News of a bipartisan effort underway in the U.S. Senate to reform the housing finance industry is a welcome development, but the devil is in the details.

Almost a decade after the financial crisis, in addition to repairing damage caused by the flawed Dodd-Frank law, policymakers must work swiftly to wind-down Fannie Mae and Freddie Mac, the two institutions at the heart of the last financial crisis.

Failing to reform the housing market is Dodd-Frank's biggest omission. Doing so now is essential to preventing future taxpayer bailouts and protecting the hard-earned savings and investments of American families.

Key to reforming these government-sponsored entities (GSEs) is deconstructing the Obama-era financial crisis narrative: that the Great Recession was due principally to insufficient bank regulation and dodgy Wall Street behavior.

To do so, policymakers should turn to Peter J. Wallison's 2014 book, Hidden in Plain Sight. Wallison makes a compelling, thoroughly-documented case that government housing policies were "the sine qua non of the crisis – the element without which there would not have been a widespread financial breakdown in 2008."

The GSEs provide a liquid secondary mortgage market by buying loans from mortgage originators so they in turn have funds to extend more home loans. Until 1992, they followed traditional underwriting standards in determining which loans to acquire (very few with down payments below 3 percent).

"Destabilizing housing policies that brought about the crisis must end, along with Fannie and Freddie."

But the GSE Act of 1992 set aggressive targets for them to purchase loans originated to borrowers at or below the median income level – many of whom were "subprime." To meet the goals, the GSEs lowered underwriting standards for mortgages they purchased from originators, who before had little incentive to originate poorly underwritten loans, Wallison explains.

Because of the GSEs' large market share, low- and moderate-income level lending targets – first set at 30 percent – had immediate nation-wide impact: in 1989 just 7 percent of mortgages were made with a down payment below 10 percent, but by 1994, the share of low down payment mortgages had grown to 29 percent. The Department of Housing and Urban Development steadily increased the targets to 55 percent through 2007, causing underwriting standards to concurrently fall along the way. By 2007, two in five loans acquired by the GSEs were made with down payments below 3 percent.

Competition for market share between the GSEs and the Federal Housing Administration – which offers federally-backed mortgage insurance to enable low down payment lending to low-income and first-time home buyers – further accelerated the nation-wide decline in underwriting standards.

This increased the number of prospective home buyers and thus demand for homes, creating a housing price and construction bubble that spanned 1997 through 2007 and dwarfed the largest of all previous such bubbles by a multiple of nine. When the bubble popped, low- and middle-income American families were hit the hardest.

In a 2010 CNBC interview then-Representative Barney Frank expressed hope for substantial GSE reform: "I hope by next year we'll have abolished Fannie and Freddie…it was a great mistake to push lower-income people into housing they couldn't afford and couldn't really handle once they had it."

Yet today, the GSEs remain in federal conservatorship almost a decade after the crisis as a "temporary" federal takeover continues, leaving taxpayers on the hook for $5 trillion of risk.

As U.S. Senators Mark Warner (D-VA) and Bob Corker (R-TN) again undertake work on legislation to overhaul the housing finance industry, they should turn to House Financial Services Committee Chairman Jeb Hensarling's 2014 Protecting American Taxpayers and Homeowners Act for a road map on how to appropriately wind down the too-big-to-fail GSEs and end U.S. housing policies behind the last subprime mortgage boom – and its tragic bust.

Simply setting up a new government agency that mimics the GSEs' habit of pursuing so-called affordable housing targets, while leaving taxpayers on the hook for losses, is unacceptable. Destabilizing housing policies that brought about the crisis must end, along with Fannie and Freddie.

Congress should certainly maintain its focus on undoing the economic havoc caused by Dodd-Frank. But, as Peter Wallison so effectively pointed out, it must not lose sight of the need to address Dodd-Frank's biggest omission – Fannie and Freddie.

The threat to our financial system remains, and until Congress winds down the GSEs and ends the federal government's destabilizing role in U.S. mortgage finance, efforts to improve U.S. financial market stability will be met with only limited success.

Commentary by Paul Atkins, Patomak Global Partners CEO. He is a former SEC commissioner and was a member of President Donald Trump's transition team. He is currently serving on the president's strategic forum.

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