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REFORMING THE MORTGAGE SYSTEM & IT

CAN WORK IN NEW ZELAND


George wrote for Politico on how to deal with Fannie Mae and Freddie Mac. Source:

http://www.politico.com/news/stories/0310/35030.html

By George Soros
 
Treasury Secretary Geithner testified Tuesday on a long-term plan to reform Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSEs) now in limbo.   But we don't have to wait for years to reform the mortgage system -- there's a better approach that could be introduced right away. 
The business model of Fannie Mae and Freddie Mac is fundamentally unsound.  These public-private partnerships are supposed to serve the public interest as well as the interest of shareholders. But the interests were never properly defined and reconciled. Managements' own interests were more closely allied with the shareholders. They had an incentive to lobby Congress -- both for expanding homeownership and for protecting and exploiting their government-sponsored duopoly status.  The GSEs gradually extended their activities from insuring and securitizing mortgages into building highly leveraged portfolios of securities, taking advantage of their implicit government backstop.  The GSEs profited from the growth, without bearing the risk of collapse: Heads we win, tails you lose.  The GSEs already had a checkered history, riddled with accounting irregularities. Eventually, they blew up -- at an enormous loss to the taxpayer, which some estimate will exceed $400 billion.

 

   


Early in the century, private enterprise had started eating into the government-guaranteed mortgage market. Borrowers once served by Federal Housing Administration loans turned to subprime and alt A mortgages. These "non-agency" mortgage securities gained increasing market share. They were sliced and diced, repackaged into CDOs and CDOs squared.


Geographic diversification was supposed to reduce risk. But the originate-to-distribute model of securitization actually increased risk by creating a severe agency problem: Agents were more concerned with earning fees than protecting the quality of the mortgages. The housing bubble ended with a crash -- and the government was forced to take over the GSEs.


With the private sector largely incapacitated, the GSEs and FHA became virtually the only source of mortgage financing. So we are in the paradoxical situation where a fundamentally unsound business model holds a quasi-monopolistic position. This cannot last.

What needs to be done is clear: The GSEs' mortgage insurance function  must be separated from the mortgage financing. The former, mortgage insurance, is the legitimate function of a government agency -- especially when the private sector has collapsed. It should be run as a government agency. But mortgage financing should revert to the private sector. This would get rid of a business model that has failed. There is a proven mortgage financing system already up and running. The Danish model has been in use, continuously, since the aftermath of the Great Fire of Copenhagen in 1795.  It has not prevented housing bubbles from developing, but it has never broken down. And it proved its worth again in 2008. 
In the Danish system, homeowners do not borrow from either a mortgage originator or a GSE. They borrow from the bond market, through a mortgage credit intermediary.  Every mortgage is balanced by an equivalent amount of an identical, and openly traded, bond.  This is called The Principle of Balance (POB).
In the United States, mortgage securities are separated at birth from the borrower.  Thereafter, they lead separate lives.  But in the POB system, the link between homeowner and  security is never broken. 
Mortgage Credit Intermediaries, or MCIs, operate the POB system. They help homeowners understand and navigate the process. Most important, MCIs bear the credit risk of the mortgages - they remain "on the hook" in the event of delinquency or default. 


In Denmark, these mortgages are not insured by a government agency. This would have to be modified in America. Given the current demoralized state of the market, a government agency would have to guarantee mortgages, but the MCIs would be required to keep "skin in the game" with  a stake of, say, the top 10 percent. 
A key benefit of the POB system is that it offers performing homeowners the opportunity to buy back their loans when interest rates rise. If the price of the associated mortgage bond drops, the homeowner can buy the equivalent face value of bonds at a discount, and use it to redeem the existing home mortgage loan. 
The homeowner's ability to lower his mortgage liability reduces the chance that he will be underwater when home prices fall due to a rise in interest rates.
This helps forestall foreclosure crises. And it would have a valuable counter-cyclical effect: Homeowners repurchasing mortgages help moderate upward pressure on interest rates.  By contrast, the current system tends to exacerbate upward pressure by lengthening duration, a likely near-term prospect.
This system would have many other advantages over the system that has now collapsed here.
It would eliminate the agency problem that was the primary cause of failure. It would separate the credit risk from the interest rate risk. It would be completely transparent. And it would be open: the duopolistic position of the GSEs would disappear.  What would remain is a government agency offering mortgage insurance to all qualified MCIs, without competing with them.


How to get there from here? Do it in steps.
The first is to introduce mortgage securities based on the Principle of Balance.  This could, and should, be done by the GSEs now, with the government regulator setting clear and conservative standards.  No legislation is required.  
The second step is to open up the process so that all qualified MCIs can issue POB bonds. To make this market work, this does mean new legislation requiring that MCIs maintain skin in the game for any federally guaranteed mortgage. 
After that, the GSEs could be phased out from their role as MCIs, and the guarantee function hived off to a government agency. Eventually, the GSEs would be liquidated, as their portfolios run off.Legislation would also be required to extend the POB system to areas that government insurance does not cover.
In fact, legislation authorizing "covered bonds" is now making its way through Congress.
But it should better take into account the lessons of the last crisis -- and begin the introduction of the Danish model.   This should be part of the financial reform package. We could start rebuilding a stronger mortgage finance system along these lines now.


George Soros, philanthropist and financier, pioneered the introduction of the Danish mortgage finance system in Mexico with the support of then Treasury Secretary Paul O'Neill.  He now participates in a joint venture with the Danish financial system to help countries use this approach.

 

STATE OF THE UNION ADDRESS USA:

 "It's all Bush's fault!! ..."

will another crash happen & what a mess we are in

[ Kiwisaver good or bad Providers ]

WHY ARE MANUFACTURERS & BUSINESSES LEAVING NZ: [ Read the story ] The issues are economics nothing else and many a time the owner is blamed for moving when in fact he has no say in the matter otherwise he will go bust. However read the reasons why NZ has lost the plot ---[ Compare to Thailand ] & why more factories are heading abroad now. It makes sense.[ Check WHY THAILAND ] is better for Manufacturers & any Kiwi Company. Why NZ is lost [ NZ Deficit increases ] Yes we owe money????? [ Government $250m a week borrowing ] [ Transmission Gully Impact costs ] [ Kiwi Family Savings Plan ] [ Benefit cuts good or meaningless ] [ Quit smoking-heres how ] [ Levin Business dying ] [ NZders lose out ] [ World population exploding ]

"I hope they don't change the Kiwisaver rules anymore "

 
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