As our banking giants engaged more and more in speculation, and as the shadow banking system saw a way to make money off of people's bad financial decisions by betting against subprime loans, the financial crisis took off. So redressing the problems that caused the crisis shouldn't overlook mortgages.
The Treasury has now come out with a "plan" for addressing the government sponsored enterprises Fannie and Freddie, which played a role in the crisis though were not the drivers of the subprime origination mess. The plan, Reforming America's Housing Finance Market: A Report to Congress (Treasury and Housing and Urban Development, Feb. 2011), claims that it will "reform America's housing finance market to better serve families and function more safely in a world that has changed dramatically." It also claims that it is intended to limit the government's primary role to "robust oversight and consumer protection, targeted assistance for low-and moderate-income homeowners and renters, and carefully designed support for market stability and crisis response."
Both of those claims are worrisome. First, the alternatives proposed seem better designed to serve the financial services industry than famililes. Not only is there still no provision for mortgage modification in bankruptcy, but securitization is intended to "continue to play a major role in housing finance", even though the securitization process has brought a nightmare of foreclosure mills and uncertainties about who owns debt and has the right to foreclose. While the Administration walks the GOP-favored walk of decreasing government/increasing private markets, it nonetheless leaves government as the one that backstops the private mortgage market, retaining the possibility of private gains and social losses.
Second, the statement that government will be limited to "carefully designed support for market stability and crisis response" means that the government will continue to backstop the securitization losses, as Yves Smith at Naked Capitalism puts it in The 7 Things Really Wrong with the Treasury's GSE Proposal:
Of the Treasury three proposals, the last is the same as one advanced by the big guns, from the Mortgage Bankers Association, the Fed (both the New York Fed and the Board of Governors), the Financial Services Roundtable and Mark Zandi of Moodys. This alternative preserves too many bad elements of status quo ante, in particular significant and largely hidden subsidies for banks, for anyone to hail it as reform. Although each proposal has some distinctive wrinkles, all call for the creation of “private” entities that would provide insurance to mortgage backed securities that would then be reinsured by the government, with a full faith and credit guarantee.
What is to prevent huge public losses? The proposal relies on a guarantee fee and higher bank capital requirements. This isn't good enough because it builds too much on the status quo ante. Yves Smith provides her list of the Treasury proposal's problems:
- The most pressing problems related to the crisis of abuses in the housing securitization markets outside of Fannie and Freddie are still not addressed
- The plan continues to use a poor tool to address housing goals, by focusing on mortgage financing.
- Reliance on the old 30-year fixed rate prepayable mortgage is outdated and fails to address today's markets.
- Continued use of the private (owners of the entities)/public (backers of the entities debts) structure is fated to suffer the same problems with increasing risk and lobbying as Fannie and Freddie
- This just props up the housing market; it isn't really a help to consumers.
- The new entities will continue the conflicting roles of the pre-crash Fannie and Freddie of propping up liquidity and making credit decisions.
- There's nothing to keep these new entities from being too big to fail.