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Back to the future: Time to privatize the mortgage-finance system

It is now more than five years since Fannie Mae and Freddie Mac were ignominiously put into conservatorships and became wards of the U.S. government — at a cost of $188 billion. They have continued to function during these five-plus years, and have even become profitable again. But it is long past time to give them a decent burial — and also to make sure that clones don't spring up to replace them.

Mortgage finance used to be largely the business of private markets. But Fannie and Freddie's expansion as mortgage investors and securitizers in the 1990s and the first half of the 2000s — and then their spectacular collapse in 2008 — has brought heavy government involvement into the mortgage markets. Recent proposals to "reform" mortgage finance would keep that extensive involvement. This would be a costly policy mistake.

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For the past two decades, the process of mortgage securitization — whereby hundreds of mortgages are bundled into securities, which are sold to investors — has revolutionized mortgage finance. No longer are the corner bank or savings institution (and, really, their depositors) the only sources of finance for a home buyer who needs a mortgage. And Fannie and Freddie, with lots of help from the government, were at the forefront of that revolution.

Read MoreFannie Mae and Freddie Mac must not die: Dick Bove

But keeping Fannie and Freddie in business, or replacing them with clones, means that the government — which really means taxpayers — will continue to be subsidizing mortgage borrowing and to be exposed to the risk of having to bail out these entities once again.

There is a better way. That way starts with the recognition that there will still be an extensive role for government — and this is not the screed of a "free markets crazy." Government should still be helping properly qualified, low- and moderate-income potential first-time home buyers to become actual home owners — preferably, through helping them save for their down payments. But this assistance shouldn't extend to subsidizing mortgage finance more widely, which has primarily encouraged tens of millions of home buyers to buy bigger houses than they otherwise would and to leverage themselves excessively. What worthwhile public function is served by that?


Next, Fannie and Freddie need to be phased out — probably over the space of about five years. They will be replaced by a combination of expanded lending by banks and savings institutions (which, after all, held 30 percent of all mortgages as recently as 2007) and by a revived system of private-market securitization. Yes, private-market securitization "blew up" in 2008, along with Fannie and Freddie. But, having gone through all of this, the private mortgage-finance participants are surely sadder and wiser. They will be examining the securitization bundles for safe mortgages by creditworthy borrowers. The days of the "liar loans" and other flim-flam arrangements are, fortunately, history.

Read MoreBill Ackman boosts his stake in Fannie and Freddie

Government can aid this process by finalizing clear regulatory "rules of the road" for such securitizations. In addition, the life-insurance industry and private and public pension funds can be expected to support the revived private-mortgage securitization. On a combined basis, they have over $12 trillion to invest. They are natural buyers of long-lived assets, like securities based on 30-year mortgages, to balance their stretched-out obligations to future retirees and beneficiaries. Reasonable fees when borrowers pre-pay their mortgages would surely help.


Government also has a regulatory role to make sure that any private guarantors of mortgage securities have the financial strength to honor their guarantees. And it probably wouldn't hurt for government constantly to remind all participants in the mortgage market about the importance of sizable down payments, borrowers' financial capability for making monthly payments, and good credit histories as the bulwarks for a safe, privately financed mortgage system.

Read MoreOp-ed: Don't be fooled by housing-finance reform lies

In sum, private finance can — and should — again become the dominant mode for residential mortgages in the U.S. Where is Marty McFly when we really need him?

Commentary by Lawrence J. White, a professor of economics at the NYU Stern School of Business. He was a board member of the Federal Home Loan Bank Board from 1986 to 1989, with governmental responsibilities that included being a board member of Freddie Mac. He is also co-author of "Guaranteed to Fail: Fannie Mae, Freddie Mac, and the Debacle of Mortgage Finance."

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