Republican Financial Reform and the GSEs

I forgot to mention this at the time, but Annie Lowrey wrote “A ‘Disastrous’ Republican Proposal to Redo Fannie and Freddie”, which you should read as it is going to lead into one of the two next battles for finanical reform in 2011, and that is GSE policy.

Two things of note:

1) I think it would be sort of punk rock if McCain had called his plan the “Bomb The Suburbs” amendment, because it would have immediately destabilized every suburban dwelling overnight.

There are a lot of people who think that the suburbs are the way they are as a result of things like “a free market” and “individual choices.” Yglesias writes really well here about this problem when it comes to zoning. All I would point out is that a 30-year mortgage and the suburban landscape would not exist without some sort of liquidity “last resort” functioning from the government.

Indeed the whole initial growth of the suburbs was a result of the GI Bill and other mid-century planning mechanisms. Zoning is one thing, but the actual model of homeownership is so deeply embedded in our 20th century government that pulling the plug on it overnight would send shockwaves through the entire national market. (We’ll have more on all that over the next months after this bill gets across the finish line.) Hence I really wished McCain had tried to go bipartisan and gotten some lock down dates rather than the hasty poorly thought out mechanism Lowrey describes.

2) Why didn’t the GOP already take down the GSEs when they could have? Remember that the GOP has wanted to tear down Fannie and Freddie for a long time, and they did run the government from 2000-2006. Even though in late 2004 there was a massive scandal with Fannie, they didn’t seem to do anything major about it. Rather than trying to get their arms around the GSEs and force something out of the banking committee, they blew their political capital on Social Security reform instead.

Why weren’t the GSEs more on the GOP agenda during the 2000s? All they seemed to try to do during that time was replace one set of regulators with another.

Here’s an editorial Greg Mankiw wrote in the Financial Times, February 24, 2004, when he was chairman of President George W. Bush’s Council of Economic Advisers, laying out a financial reform package for the GSEs:

Because the housing GSEs are so large, the risk they face is important for the entire financial system. GSE debt is widely held by other financial institutions. Even a small mistake in GSE risk management could have ripple effects throughout the economy.

Although there is no way to eliminate the underlying risk, it is possible to reduce it by ensuring that the housing GSEs are overseen by an effective regulator. This should have authority to set both risk-based and minimum capital standards for GSEs; to review and, if appropriate, reject new GSE activities; and to wind down the affairs of a troubled GSE through receivership. Instead of relying on the congressional appropriations process, it should be granted a permanent funding mechanism by allowing it to assess the GSEs under its purview.

The reform effort should also re-evaluate GSEs’ privileges. A useful step would be to remove presidential directors from the boards of Fannie and Freddie.

Nobody is willing to reign in and regulate the GSEs so the solution is to….have another regulator. But this time really mean it! Also mess around with the composition of directors on a board. Move people around on an org chart.

The resolution authority-like receivership works only if you will credibly use it. And it was never credible that we would have forced a creditor, say the Chinese, to eat a haircut on their GSE debt, even if we waved a really serious resolution authority around in 2005. So that certainly wouldn’t have helped.

This doesn’t seem like anywhere near enough to handle what needs to be done. I don’t know enough from this time period, and maybe it was simply too late to make any big changes. Maybe doing so would have sent everyone panicking? I’d like to hear more about what worked and didn’t from people closer to the on the ground efforts in 2004.

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5 Responses to Republican Financial Reform and the GSEs

  1. chris says:

    Buying real estate on credit isn’t such a great deal unless it’s heavily subsidized, and the subsidies are distorting and expose the government to risk. But homeowners and aspiring homeowners are WAY too politically powerful to tear down the system now that it is there. (Especially suddenly.)

    Basically, the existing system is a tax on renters for the benefit of mortgage lenders (the actual homeowners are only an intermediary), which everyone would recognize as insane if it were done openly. So it’s not done openly.

  2. nadezhda says:

    The first question you must ask in understanding GOP behavior is why they hate the GSEs. It tends to be a somewhat on-again-off-again thing that depends on the market. It has nothing, truly nothing, to do with systemic risks etc. and everything to do with the myopic perspective of the banking industry whose interests they represent or whose ideological proclivities they share.

    IF GSEs are doing a lot of apparently profitable business, the banks see the GSEs as their “competitors” who are taking advantage of government support to steal the business to which the banks have a God-given right. So that’s why you saw a bunch of GOP attention paid to the GSEs during the run-up and height of the housing boom (see date of Mankiw op-ed) when the banks could peddle all sorts of ABS into the primary issue market without government backing. The “serious concerns” of the banks/GOP became more muted in the latter stages of the bubble when the GSEs became the indispensable stuffees for much of the RMBS drek the banks were manufacturing. Though even then, some ideological ding-dongs still complained that the GSEs were recapturing market share at the “expense” of the banks.

    The smarter Republicans, like Mankiw, actually understand how foundational the GSEs are to the entire structure and function of the housing industry and US political economy. So they tend to go for ways to rein in but not destroy the GSEs. Although we should note that Mankiw’s proposal for adopting a resolution regime would go a long way toward destroying them, since it would in effect nullify the implicit government guarantee which is the sine qua non of the GSEs.

    What he wanted to see, by raising the costs of funding for the GSEs, was a dramatically scaled down GSE sector that would be left with marginal business — the GSEs as essentially a liquidity provider to smooth the volatility of the primary issue market.

  3. sraffa says:

    This Republican plan is crap as usual, but I also don’t think the way the GSE’s are run is healthy. They are offering housing loans with 3.5% downpayments. Do we really want households to have 30/1 debt to equity ratios? A 4% drop in prices makes them underwater. And that would never happen….

  4. Ed says:

    This is tangential and not particularly useful, but the first chapter of my dissertation was about how the Federal government essentially built the suburbs. The GI Bill recipients could get mortgages *on their signature.* No money down, no complicated “teaser” rate, nothing. Just walk in, sign the paper, and start mowing the lawn.

    The country literally had a housing shortage at that point – as far as single-family homes were concerned. Plenty of urban rental property, but there was a lot of “Let’s build an ownership society” stuff floating around then. And where else were they going to build tens of thousands of new housing units, all on spacious lots, except beyond the outer ring?

    Of course the Interstate Highway Act can’t be overlooked, because the only feasible way to sell homes in Park Ridge is by giving people a convenient way to get into the city for, you know, jobs and stuff. And since public transportation is for pussies…

  5. Dollared says:

    “Bomb the suburbs.” I love you, man.

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