Perhaps the biggest surprise of the Asset Securitization Forum conference so far was during a session on Tuesday about the future of the government-sponsored enterprises Fannie Mae and Freddie Mac. The panel, consisting mostly of mortgage bankers and investors, debated how the GSEs should be reformed. While I had expected the Wall Street crowd to champion the free market and declare that these troubled entities should be wound down, and that the private market should take care of housing market liquidity going forward, I heard a quite different answer. Most panelists wanted the government to remain involved in the liquidity business.
First, the panelists agreed that it was probably best to separate out the two major functions that the GSEs serve currently: providing market liquidity and helping to create more affordable housing in the U.S. I recently wrote that House Financial Services Chairman Barney Frank (D-MA) made a similar statement. He wanted those priorities left to separate entities as well.
It's pretty clear that government officials would be the ones who would want to create more affordable housing. But it's less clear that Washington should be where liquidity comes from. After all, that's what a market is for. So later in the session, the moderator asked whether the government should get out of the liquidity business. I was shocked at the responses.
Most of the panel agreed that the government should continue to support some agency to provide liquidity to the mortgage market. Garry Cipponeri of JPMorgan didn't believe that privatization would work, because there would be a lack of consistency if the government wasn't in charge. But more importantly, he thought the price shock would not sit well with the market: investors would have to add a risk premium if Uncle Sam wasn't standing behind half of the mortgage market.
Another panelist Wellington Denahan-Norris,CIO and COO of Annaly Capital Management, agreed. She was unconvinced that the market would be able to live with the new risk pricing if mortgage liquidity providers were completely private. This would curtail lending and make it more expensive for consumers to get mortgages.
A third panelist, Armando Falcon, CEO of Falcon Capital advisors, also wanted government ownership of an entity in charge of liquidity. He even suggested that the Federal Reserve could serve this function if it made its mortgage security purchase program permanent.
Only one panelist disagreed: James Lockhart III, vice chairman of WL Ross & Co. and former director of the Federal Housing Finance Authority. He wasn't prepared to reject the notion of privatization entirely. When Cipponeri asserted that the absence of a government liquidity provider would raise funding costs by as much as 150 basis points, Lockhart thought it might not be that much.
This is kind of amazing. What you have here is a group of investors and bankers who would prefer to keep the government propping up the market so that costs remain low. This idea spits in the face of free market economics. It would dictate that if the market demands a higher price for mortgage funding, then that's what the price should be. Indeed, if recent history has taught us anything, then it's precisely that mortgage funding was entirely too cheap and easy. That's what created the housing bubble. If costs were higher, then fewer mortgages would have been originated, and credit quality would have been better as well.
Also interesting is that all of these panelists essentially agreed that the two objectives of providing liquidity and making homes more affordable should be separate. But, in a sense, providing liquidity also makes homes more affordable. If something is more liquid, it has cheaper transaction costs. So if the government kept liquidity artificially high, then prices would be kept artificially low: it couldn't escape the dual purpose of providing liquidity and also making home ownership more affordable, since banks' funding costs would be lower as a result.
This is a great illustration of where businesses only support the free market until it costs them to do so. As soon as Wall Street realizes that a privatized mortgage market liquidity provider might increase funding costs and decrease loan volume, all that great free market philosophy goes right out the window. After all, that could make their bonuses a little smaller.
The truth is that there's no reason the U.S. needs government-sponsored entities to provide mortgage market liquidity. Other countries leave that function in private hands, and their mortgage markets function perfectly well. Indeed, given the disaster experienced by the U.S. mortgage market over the past few years, those other nations' mortgage markets may perform even better.
