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Letting the market work

By: 21 February 2011 One Comment

After months of anticipation, the Barack Obama administration released a plan to reform the secondary mortgage market that is decidedly capitalist in approach.

Yes, the Obama administration has proposed putting together a secondary mortgage market that is primarily financed by private capital. That’s a bit of a departure from what we’ve had for the past few decades and is well worth discussing.

Here’s a fact to consider – over the past couple of decades, taxpayers have been tapped for over $500 billion to cover the government’s losses following one plan after another to help people buy homes. The most recent round of losses actually started back in 1992 when Fannie Mae and Freddie Mac – the two government sponsored enterprises (GSEs) – were directed to make money available for potential home buyers who couldn’t meet the requirements necessary to take out prime mortgages.

A good amount of money made available for those loans backed by Fannie and Freddie came from the mortgage backed securities market. Mortgages, then, were packaged as securities and sold to investors. That system worked well enough so long as people didn’t default on their mortgages.

We know the rest of the story. Credit standards in the secondary mortgage market – the subprime market – became more and more lax, resulting in a lot of homes purchased by people who couldn’t pay back their mortgages. The result? Foreclosures, an economic mess and a federal government that couldn’t help the problem by throwing money at it.

Obama’s undoubtedly been under pressure to “do something” about the foreclosure crisis since taking office in 2009. In mid-February, the Obama administration released some options on how to reform the secondary mortgage market and one of them tracks closely with what the Mortgage Bankers Association proposed 18 months ago – limited involvement of the federal government in the secondary mortgage market.

Indeed, that particular option would rely mostly on private capital with a guarantee fund set up by the federal government to protect taxpayers should another “mortgage crisis” hit and the decision is made to bail out the market. In other words, that particular option would set up a system through which mortgage-backed securities are still utilized to provide capital for a secondary mortgage market, but the risk to investors – and taxpayers – would be decreased through a limited government guarantee.

It’s also worth pointing out that the proposals are a direct response to a desire to reform Fannie Mae and Freddie Mac. There are essentially three options from the Obama administration on how that is to be done, but they all have something in common – the scaling back of Fannie Mae and Freddie Mac and a faith in private investors to step in and pick up the slack when the government reduces its involvement in the mortgage market.

The trick, of course, is to make sure money is available to potential home owners who can handle a mortgage but don’t qualify for a prime one. The name of the game is reducing risk, but not overreacting to the point where people who ought to be able to purchase homes can’t do so.

That’s quite a balance game and – at least for that reason – Fannie and Freddie reform is something that’s sure to discussed at length in the months to come.

Column written by Ethan C. Nobles and distributed to Arkansas publications on behalf of the Mortgage Bankers Association of Arkansas.

About: Ethan C. Nobles:
Benton resident. Rogue journalist. Recovering attorney. Email =

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