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Redirecting Default Risk Away From Taxpayers

credit riskA new report co-authored by Robert C. Pozen, non-resident fellow of the Brookings Institution and a senior lecturer at MIT Sloan School of Management, and Clayton Pfannenstiel, a graduating MBA student from this same school, takes a deep dive into the mortgage default market. Specifically, it mines the issue of moving that risk from taxpayers to investors. Here, we telegraph the key points and look at how that notion could affect you.

Ever since the financial crisis, the Fed has expanded its role in propping up the residential mortgage marketplace, the authors write. Although the current outstanding balance of single-family mortgage debt sits a smidgen below the 2008 high of $11 trillion, the share of new home mortgages guaranteed by the GSEs and related federal agencies now eclipses 70 percent, compared with about 35 percent in 2006.

“These statistics raise important policy questions about the U.S. government’s role in supporting the home mortgage market during normal times and in housing recessions,” Pozen and Pfannenstiel say. “After the financial crisis of 2008, taxpayers have rebelled against bailing out financial firms in the mortgage market. Yet, public officials still endorse government subsidies to help achieve the social benefits of homeownership.”

As such, the report explains that Congress is unlikely to mobilize a bipartisan majority to pass any of the proposed reforms. “At one end of the spectrum, some Republicans have called for the re-privatization of the GSEs, on the assumption that the mortgage market could function without any government guarantee,” they write. “At the other end of the spectrum, some Democrats want to treat GSEs as public utilities owned or regulated by the federal government.”

Consequently, the task of trimming taxpayer risk within today’s mortgage space has been left to the GSEs, they say. So far, the largest GSE initiative has been Fannie Mae’s Credit Risk Transfer (CRT) program (which is known as Connecticut Avenue Securities, or CAS).

We applaud Fannie Mae’s efforts to date, especially those to expand the investor base for CRTs by adopting a better tax structure,” Pozen and Pfannenstiel write. “Nevertheless, we believe that Fannie Mae should increase the amount of credit risk it transfers to CRT investors; and the guarantee fees charged by Fannie Mae to mortgage originators should be based on the implied guarantee fee paid to CRT investors.”

Despite the success of CRTs, they note, the authors believe Fannie should continue to examine two key questions: How much risk should the firm transfer using the CAS program? And what should the effect of CRTs be on the guarantee fees charged to mortgage originators (and passed on to borrowers)? 

They conclude their paper with the following commendations and suggestions: “In short, although the prospects of legislative reform of the GSEs are dim, innovative officials at Fannie Mae have created CRTs, which lessen the risk for taxpayers without disrupting the government’s support of home mortgages. We applaud Fannie Mae’s efforts to expand the market for CRTs, especially by adopting a better tax structure. We encourage Fannie Mae to expand the amount of risk transferred by CRTs to investors in order to protect taxpayers from an even worse financial crisis than 2008. Finally, the FHFA should rely on CRT pricing to lower the guarantee fees charged by GSEs to mortgage originators in order to lower the cost of home mortgages to many borrowers.”

About Author: Alison Rich

Alison Rich has a long-time tenure in the writing and editing realm, touting an impressive body of work that has been featured in local and national consumer and trade publications spanning industries and audiences. She has worked for DS News and MReport magazines—both in print and online—since they launched.

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