A third path for housing finance reform


Although the housing market has slowly recovered, thanks in part to the stabilizing role played by the government, government-backed mortgages now account for more than 90 percent of U.S. market. Housing finance has become nationalized without notice. This is bad for taxpayers and consumers.  In this context, it is critical that we get housing reform right, which means allowing the private sector to return to the business of financing home loans, while protecting needed social investments in affordable housing and weaning the housing market off of extraordinary levels of government involvement without jeopardizing the nascent housing recovery.
 
Thankfully, there is recent movement in Washington towards much-needed reform. This month, the president voiced his support for winding down the GSEs and a larger role for the private sector.  In June, Sens. Bob Corker (R-Tenn.) and Mark Warner (D-Va.) introduced legislation (S. 1217) that creates a new housing finance system, which allows Washington to continue to support housing through a government administered insurance program.  In July, the PATH Act (H.R. 2767) was introduced in the House by Financial Services Chairman  Jeb Hensarling (R-Texas) and Rep. Scott Garrett (R-N.J.), which removes the government from most areas of housing finance.
 

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These are both important pieces of legislation that begin the debate on what to do with a broken system. I applaud Corker-Warner for its focus on issues of affordability and the PATH Act for its focus on returning market discipline to housing. However, I worry that the debate will become ideologically fractious, driven by a false choice between either no role whatsoever for government or continued exceptionally high levels of government involvement. In my judgment, there is a third path - allowing government to expand the capacity of the housing market but only on market terms and with taxpayers protected from further loss.
 
Under my approach, which was discussed during committee markup of the PATH Act, mortgages would be securitized following their insurance for full principal and interest repayment by well-capitalized, privately funded mortgage insurers.  These primary insurers could be the originator of the loans or simply a holder of risk – but in either case, they would be obligated to retain the full first loss of no less than 5 percent on each loan, ensuring “skin in the game.” These primary insurers could then, at their option, obtain reinsurance (insurance for their insurance) for their exposure beyond this first loss retention (in this case, up to 95 percent) from the government, perhaps through Ginnie Mae. But this reinsurance would be available if and only if they also a secure a minimum level, say 10%, of pari passu reinsurance from a well-capitalized private market reinsurer.  The government would be required by charter to obtain the same pricing, terms and conditions as the private provider of reinsurance.  The best attributes of government involvement (its extremely high level of highly rated financial capacity and its ability to increase this quickly in a crisis) are thus combined with the best attributes of the private market (pricing risk).

In addition, as the profitability of the government’s reinsurance participation is demonstrated over time, the private market could be incentivized to "dial back" the government’s share of the program in favor of additional private market participation.  Profits the government earns on its market priced reinsurance participation can be invested specifically to support affordability programs.
 
This approach accomplishes two important policy goals.  First, it ensures that the private market prices every component of housing finance - something the private market is much more capable of doing than the government.   Second, it allows the government to materially expand the capacity of the U.S. mortgage market.  The U.S. mortgage market is the second largest fixed income market in the world. Leaving it alone without any form of government participation will decrease stability for American families, which is not in our nation's best interest.
 
Housing reform will not be easy, but both Corker-Warner and the PATH Act have materially moved us closer to a solution. Triangulating between too much and too little government involvement in housing is essential.  Thus, we can preserve the American innovations in housing that created middle-class home ownership in the wake of the Depression and allow the private sector to create a more competitive, consumer and taxpayer-friendly market.
 
Important and successful economic policy is always done at the intersection of principle and compromise.  Reforming housing finance is a top economic priority for our nation and I’m excited that the debate has finally started.
 
Delaney represents Maryland's 6th Congressional District. He is the Democratic freshman class president in the House and sits on the Financial Services Committee. He is the only former CEO of a publicly traded company now serving in Congress.