It looks like the Obama administration is going to introduce a range of policy options later this week for how they would like Congress to change the way the GSEs and the mortgage market. Maybe there will be good solutions proposed, but based on the fact that administration allies and bank lobbyists are basically pushing the same set of reforms for Fannie and Freddie, I’m not terribly optimistic.

Yves Smith writes:

It’s as if a population suffering from a toxic reaction to mustard was now offered options ranging from Dijon to pommery to spicy brown as meaningful improvements. And this is not an exaggeration. The new GSEs (and let us not kid ourselves that that this is where the Powers That Be are driving this effort) would have an explicit government guarantee, be larger in number, and supposedly have higher capital buffers.

The problem is that any government sector guarantee for a private sector entity is a terrible idea absent very tough constraints on operations, which is the still-unlearned lesson of the financial crisis. And the idea that any higher capital standards will hold over time is dubious. Fannie and Freddie were enormously powerful lobbying forces, a de facto mainly Democrat slush fund; any new GSEs will have similar collective clout and will press for their agenda on a unified basis, which is certain to include waivers that will amount to lower equity requirements. Increasing leverage is one of the easiest ways to improve performance in a financial firm.

Now the Administration is also allegedly presenting some elements of securitization reform on Friday. We’d be glad to be proven wrong, but we anticipate any proposals will be cosmetic and/or insufficient in scope. The real problem is that the coming staged fight over GSE reform will serve as a useful distraction for what is really needed, which is much broader mortgage market reform. Pursing the GSE question largely in isolation is sure to produce bad outcomes.

For instance, one of the excuses for continuing to have a large role for the GSEs 2.0 is that the private securitization market is dead. But that is because the banks have been blocking reform and investors have gone on strike. But the lack of private market demand is then used as an excuse as to why we still need something GSE like to play a big role. That’s tantamount to killing your parents and asking for charity because you are now an orphan.

Smith is spot on to point out that pushing through major changes to Fannie and Freddie while we still don’t really know how the take aways from the financial crisis of 2008. But, if we’re going to have this debate now, I think a much better way to reform the mortgage market would be to stop trying to achieve policy outcomes for home ownership in the United States through GSEs or their successors and start doing it through the federal budget. If we want homes to be affordable, the government should help people directly pay for them. FHA has had a much higher success rate, fewer foreclosures because their loans had strict standards for qualification and vetting, meaning money only went to people who were good candidates for success. We should not outsource and then subsidize this behavior to public/private entities.