The most encouraging part of the Treasury's just-released report on winding down Fannie Mae and Freddie Mac is the admission of fault on Page 1. "In the past, the government's financial and tax policies encouraged housing purchases and real estate investment over other sectors of our economy, and ultimately left taxpayers responsible for much of the risk."
Good. Thanks for admitting it. Now what's next?
The Treasury's long-awaited report offers three options for what to do with the remnants of Fannie and Freddie.
The first proposal axes the two altogether, yet keeps the Federal Housing Administration and the Department of Veterans Affairs available to assist "targeted groups" of homeowners.
The second proposal mimics the first, yet gives the government authority to guarantee the mortgage market during a financial crisis. "One approach," the report says, "would be to price the guarantee fee at a sufficiently high level that it would only be competitive in the absence of private capital. It would thus only expand when needed, and that need would be dictated by the market." Smart.
A third proposal also nixes Fannie and Freddie, while providing reinsurance to soundly underwritten mortgages already backed by private insurers. The government reinsurer would only provide assistance "if shareholders of the private mortgage guarantors have been entirely wiped out," and would charge a fee to cover claims.
Any of the three would be a step in the right direction. But I would have liked to see a fourth proposal. This one wouldn't be new. It wouldn't be an experiment. It'd be modeled after a successful mortgage program already used by another developed nation.
I'm talking about Canada's mortgage system.
The first thing you need to know about Canada's mortgage market is that it works better than ours. Homeownership rates in Canada are about the same as the United States. Mortgage rates aren't drastically different. But then there's this:
Source: Canadian Bankers Association, Federal Reserve.
Whatever Canada's doing, it works.
What does it do? The backbone is that all Canadian borrowers with a downpayment of less than 20% are required to buy mortgage insurance. The largest mortgage insurer is a government-backed corporation, CMHC. CMHC charges a lofty fee -- up to 7.4% of the mortgage value -- to insure the loan.
Bottom line: There aren't many bad loans made. Most are soundly underwritten with a large downpayment. Those that aren't are probably too expensive for borrowers to obtain.
A U.S. plan could achieve something similar and go a step further, giving the private market -- smartened by the wrath of downside risk -- a stronger hand. I could see it going something like this: Require private insurance on all mortgages with less than a 20% downpayment, just like Canada. Then provide government-backed reinsurance to the private insurance when, and only when, shareholders of the private insurer have been annihilated -- just like the Treasury suggests.
Bottom line: Not many bad loans would be made, and those that are would be backed by private insurers who stand to lose everything when they screw up. When they do screw up and are wiped out, government reinsurance steps in to defend the financial system as a last resort. It's a sensible way to let the free market dictate mortgages while backstopping the economy from utter collapse.
Of course, there are other reasons Canada's mortgage market runs laps around ours. There are no 30-year fixed rate mortgages like we're spoiled with in the United States. Most Canadian mortgages reset every five years -- homeowners accept the risk of rates jumping up and down. It's scary. So Canadian homeowners quickly distance themselves from mortgages. More than half the homes are paid off, and equity represents about 70% of the housing stock. It's roughly half that in the United States. There's also almost no such thing as a non-recourse mortgage in Canada. If you default on your mortgage, the bank will shake you upside-down for your other assets. Canadian homeowners have real skin in the game. While we're reforming our mortgage system, we could steal a page out of these books as well.
Nothing's perfect. Canada's mortgage system isn't. However we choose to replace Fannie and Freddie won't be. Nearly anything, though, is better than our current system. Let's give it a shot.
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