On Friday, the Obama administration released a surprisingly strong housing finance policy report. It explains a general process to wind down Fannie Mae and Freddie Mac, and offers three alternatives for how to conduct housing finance policy without them. Each option has pros and cons, but put together they lean firmly towards free-market ideals, which arguably makes the report one of the clearest signals of President Obama's move to the center yet.
Or does it? While these three options could genuinely attest to the administration's dedication to free market principles, they could also be strategically designed to achieve some political end. There are at least three possibilities here.
Possibly the least likely, but not impossible, goal could be for the administration to use these three options to punt the issue for the time being. Perhaps the President knows that housing finance is so contentious that the split Congress isn't likely to compromise on any comprehensive reform legislation over the next two years anyway.
If that's the case, there's really no downside to the administration taking a tough stance. When Congress fails to act, the President can shake his head and say his report sought to gain widespread acceptance from Republicans, but political divisiveness got in the way. During the 2012 race, he could point to the report as an example of his dedication to the free market, without actually having to follow through with some of the strong medicine it calls for.
It's a little difficult to believe this could really be the President's strategy for one main reason: to whom would he be punting? Presumably, he intends to win reelection in 2012. Comprehensive housing finance reform would absolutely have to occur before 2016. So he would presumably be expected to stand behind the options in this report at that time, if not now.
The Government's Invisible Hand
Even though none of the three options calls for a full government mortgage guarantee for most mortgages in the U.S., the two partial guarantee plans could effectively provide the same result under certain circumstances.
One of those options calls for government mortgage guarantees that are too expensive to compete with the private market when the economy is on firm footing. In theory, federal guarantees would only be turned to when economic turmoil results in credit drying up.
But if this option is adopted, and the private market rejects taking the on full mortgage market risk even in stable economic times, then the Treasury could throw up its hands and say, "Well, we tried." And then it could price the guarantees cheaper, to where they became the market standard, much like Fannie and Freddie's guarantees have been for decades.
The other partial guarantee option would provide a sort of catastrophic mortgage insurance. In this proposal, the market would have to absorb some first loss, and the government would take on the remainder when very severe losses hit. This time, the government would only incur losses when sort of every 100-year credit catastrophes hit.
That is, unless the market balks here too. Let's say the government says that the market's first loss must be 25% of the mortgage value. If that's too much for banks and investors to stomach, then the Treasury can again shrug and lower the first loss to something much more manageable, like 5%. So taxpayers could be left with a much greater loss exposure, similar to what they had to endure when Fannie and Freddie collapsed. The Treasury could also price the premiums too low, to include a hidden subsidy.
In essence, these two of the three seemingly free market-leaning options have the capacity to be near-nationalization of the mortgage market if structured weakly. So perhaps the political strategy here is to look strong at the outset, but then blame the market for the government's more aggressive involvement in housing finance, if banks and investors refuse to take on most of the risk.
Finally, the three housing finance options could be part of a huge bluff. The real estate industry is strongly in favor of a full guarantee for most traditional mortgages. So are mortgage bond investors. It's hard to see how housing finance legislation can pass Congress without either of those two powerful groups on board.
So perhaps the administration doesn't think Republicans will ultimately call its bluff. The last thing the GOP likes to do is anger the business community. And in this case, the industry wants a government safety net, in spite of free market ideals.
As the lobbyists express their concern, Republicans might feel pressured to tone down their rhetoric and support a proposal that provides more government support than they would prefer. Then, the President can again shake his head and say: "The Republicans claim to be the party of the free market, but they're insisting that the government play a broader role in housing finance. In the spirit of bipartisan compromise, we'll go along with stronger federal mortgage guarantees, because reform here is so essential."
Or, as mentioned at the onset, perhaps cynicism should be cast aside, and we should simply conclude that the Obama administration really does want very minimal government involvement in housing finance. That's certainly possible, but there sure are some convenient political benefits to feigning support for a free market approach. Now, it's the Republicans' move.
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