The Diane Rehm Show

Thanks for joining us. I'm Diane Rehm. The Obama administration will be recommending the elimination of mortgage giants Fannie Mae and Freddie Mac. The plan would curb the government's role in housing finance. But with so many new loans originating with Fannie and Freddie, this could also add more pressure to the already fragile housing market. Joining me in the studio, Guy Cecala of Inside Mortgage Finance Publications, Mark Zandi of Moody's Analytics and Dina ElBoghdady of The Washington Post. Joining us from Ann Arbor is Michael Barr of the University of Michigan Law School and the Center for American Progress. Do join us, 800-433-8850. Send us your e-mail to drshow@wamu.org. Feel free to join us on Facebook or send us a tweet. Good morning to all of you.

Good morning.

Good morning.

Good morning.

Good to have you with us. And, Guy Cecala, if I could start with you, I realize the administration's plans are not going to be made public until tomorrow. But what do we know so far?

Well, the White House has signaled that they're going to be presenting three options without actually recommending any of the three. And they range from trying to extract or pull the government out of the mortgage market...

Completely.

Correct. To increase support in the nationalization, essentially, of Fannie Mae and Freddie Mac. The middle-of-the-road plan is to scale back the government's support of the housing and mortgage market, but continue to provide it in some fashion, either through other companies that could act like Fannie Mae and Freddie Mac, in terms of extending the government guarantee, or some mechanism to allow private sector players to have a backstop of the government.

And what about lowering maximum loan amounts?

That seems to be part of what everybody is agreeing on now. We have loan limits that were extended back in 2008 to deal with the housing crisis. They go up now to $729,750 in high cost areas, which is a very high number. If there is a floor before that, it was $417,000.

Michael Barr, tell us why the administration is thinking about putting forward three proposals?

Well, I think, Diane, what you're saying is the administration is going to focus in the first instance on the steps that the government can take using its existing authorities to begin to reshape the housing finance system, to be more stable, to provide wide access to credit, but to do it in a prudent way. And in terms of the legislative options, I think that the reason you're going to see the administration come out with more than one proposal is really to begin a conversation with the Congress that's likely to take quite a long time. So rather than, you know, stepping out with a very, very strong direction in -- that may make it hard to reach a consensus outcome with the Congress, I think you seeing the administration reach out and say, we're going to begin this conversation while we're reforming the market.

And, Mark Zandi, is it a good idea to phase out Fannie Mae and Freddie Mac?

Yes. I think there's a general consensus that the previous mortgage finance system was a failure. We can see that in the results of the financial panic, the Great Recession. So I think there's a general, broad consensus that we need to change things, and Fannie Mae and Freddie Mac should be phased out. Of course, the debate is precisely how one should do that, and that's the debate that's going to be going on for quite some time. We just can't get this wrong. This is very, very important to our housing industry, to our border economy, to the entire global financial system because this is such a big part of the global financial system.

But, considering the politics involved, there are all kinds of chances to get it wrong.

There is. I do think, though, that would argue that we should go slow and take it one step at a time and make sure that we get it right. So I don't think we need to make big changes overnight. It's something that could be phased in over a period of many years, even a decade.

And turning to you, Dina ElBoghdady...

That's it.

Got it. ElBoghdady, how might this affect home buyers and home sellers?

Well, the operative for it, as Mark mentioned, is slow. So it's going to be a rather slow process. I don't think anyone is going to feel anything immediately. But, of course, the biggest fear is that it's going to affect the cost of loans and the interest rates in particular because, right now, loans that are backed by the federal government tend to have a lower interest rate than loans that are not. And so, I mean, basically, it's oversimplified here. But if I were to lend you $100, and I know I've got a guarantee that I'm going to get that money back, I might charge you 5 percent interest. If there's no guarantee that I'm going to get that money back, I'll charge you more interest, 7, 8 percent -- who knows how high? So that's the immediate, you know, interest for buyers.

So, what you're saying is that, no matter what happens, we're likely to see interest rates go up?

Well, the thinking now -- even if we keep everything as is -- is that the interest rates are going to climb through this year as the economy improves. I mean, some are suggesting by the end of this year that interest rates might be at 6 percent. And they have been climbing. I mean, even last week, I think, interest rates hit an average for a 30-year of, like, 5.1 something, which is the highest it's been in probably 10 months.

What about the whole idea of 30-year fixed rate mortgages, Guy Cecala?

Well, that's a good question because the United States is one of the only countries in the world that's built around the 30-year fixed rate mortgage. Most countries, particularly European ones, use an adjustable rate or variable rate mortgage because that's more attuned or tied to the cost of funds of financial institutions. It protects the financial institutions from interest rate risk. And it's certainly one of the things that pushed the U.S. towards mortgage securitization, is that nobody really wanted to hold a mortgage, given the fact that it was a 30-year fixed rate, and you could be subject to interest rate swings in their portfolio.

So, as a result, we developed securitization as a mechanism to get those loans off banks and financial institutions' books. That's something we need to examine. I think the consensus seems to be that we want to preserve the 30-year fixed rate mortgage for Americans. And that's a big step to say you want to do that because it has a lot of cost. It locks you into securitization, to some extent. It doesn't make it very easy for banks that want to originate loans and hold them as investments in their portfolio to do that. So it's a big question.

Michael Barr, what do you think about that 30-year mortgage?

Well, I think Guy is right, that is it a consequential choice for the country to make. From my own view, I think that preserving the 30-year fixed rate mortgage is quite critical, and, in order to do that, we probably need to have a form of explicit government guarantee on that product. The product needs to be able to be securitized and be able to track investors from a wide range of sources. So if we want to have a system in which individual consumers have a chance to take out a 30-year fixed rate mortgages, if that's right for them, that's the structure we need.

And I would just add, I think that the reason that the 30-year fixed rate mortgage, or similar kinds of products, is important is that protects consumers against interest rate risk. And, in my judgment, individuals are not the best bearers of that risk in our economy. They are among the least sophisticated -- all of us are in relation to financial institutions. I think we want the market to bear interest rate risk, not individual consumers.

And yet, Mark Zandi, yesterday, Ben Bernanke testified and said something like the U.S. government should only back home loans as a last resort in times of economic change and then charge for that support. What do you make of that?

Well, I think that's exactly right. The form of government support that we need would be in a case of catastrophe, if things went totally wrong, like what we went through when house prices declined 25, 30 percent from their peak and we saw enormous numbers of mortgage foreclosures and mortgage losses. That's a catastrophe. In that case, I think it's important for the government to have a mechanism to step in. It has to be explicitly priced. Homeowners have to pay for that benefit, but I think that's necessary to do. And, if we do that, we'll keep mortgage rates much lower than they otherwise would be, and we'll be able to preserve that 30-year fixed rate mortgage, which, as Guy said, if you go to other parts of the world, it just does not exist because they -- we don't -- they don't have that kind of government support.

How did they do that so different from the way we do it?

Well, they're adjustable rate mortgages. Everybody has a mortgage that adjusts with market rates. I mean, go to Australia. The banks can raise interest rate at will, and they do. Their rates will rise, so it becomes very difficult to manage your finances in that environment. I mean, I give lots of talks across the country, and the one thing that I hear universally from people is they like that fixed rate mortgage. They want that fixed rate mortgage, and I think that's one of the most attractive features of our mortgage finance system.

Guy Cecala.

And one of the other unique features that comes along with a 30-year fixed rate mortgage is refinancing activity. That's something you don't see in other countries because the institutions raise or decrease the rates whenever their costs go down, and so there's really no refinancing activity going on outside the U.S. The U.S. -- you know, we've seen 50 percent or more of mortgage activity as people trying to adjust the rates of their loans through refinancing. So that's a unique characteristic.

Dina.

And that's generally why lenders don't like to have them if there isn't, you know, some kind of guarantee. I mean, basically, they just don't want to hold on to something for 30 years when they don't know what's going to happen to it. And so that's where Fannie and Freddie step in. They say, we will be paying you back anything goes wrong with this loan, and we will sell it...

But...

They sell the loans to investors...

Sure.

...and so then investors take on that risk of the refinancing and so on.

But would that mean a higher rate of interest for a homeowner trying to purchase a loan through one of those institutions?

Well, I think the point is that if there is no government support whatsoever, even in a catastrophic situation, that investors would demand a much higher interest rate, and that would be something borne by homeowners.

Mark Zandi of Moody's Analytics. Short break and right back.

And as we talk about the administration's plans for dealing with the housing and mortgage market, perhaps even the elimination of Fannie Mae and Freddie Mac, here in the studio, Dina ElBoghdady. She covers the real estate market for The Washington Post. Guy Cecala, publisher of Inside Mortgage Finance Publications. Mark Zandi, he's chief economist of Moody's Analytics, author of "Financial Shock" and the forthcoming book, "Paying the Price." On the line with us is Michael Barr. He's professor at the University of Michigan Law School, senior fellow at the Center for American Progress, former assistant secretary for Financial Institutions at the U.S. Department of the Treasury.

We're going to open the lines in just a moment. First, here is an e-mail from James, who says, "What are the prospects of revising the tax code to eliminate the home mortgage deduction, or at least limit it to primary residents and limit the maximum deductible?" Dina.

I think that the chances of that happening any time soon are probably slim. It's not part of the debate that's going to start taking place or the administration's plan that's going to be proposed tomorrow.

Mark Zandi.

Yeah, I think that's the case. I do think, though, we should examine the mortgage interest deduction. It costs a lot of money, over $100 billion a year. I don't think it does what it's intended to do, which is to raise homeownership. I don't think there's any evidence it does that because it gets capitalized in higher house prices and does not improve affordability, and the benefit accrues to higher income, wealthier households because you can only take advantage if you deduct. And, you know, you need a certain level of income to do that.

So my predisposition would be to examine that, scale that back, broaden it so more homeowners can take advantage of it and raise some revenue because, ultimately, the housing market will get creamed if we don't address our fiscal situation because interest rates will rise. And this is one way to address it.

Michael Barr.

Well, I agree that we ought to take a careful look at the mortgage interest deduction as part of any overall set of packages designed to address our fiscal position. And, as Mark pointed out, that's important for the long-term health of the economy. At the same time, I think the prospects for that in the short-term are slim to none.

And, Guy Cecala.

I'd agree with that sentiment basically because, you know, we're talking about a sacred cow that people have put up on the chopping block for the last 25 years here and there. And the housing interests are very strong on that, and it's really never been touched. I also agree with Mark that if we do do something, it'll be scaling back or modifying it somewhat.

Now, here's another e-mail, from Rick in Louisville, Ky. He says, "I believe the Obama ideas do not address the major cause of the financial crisis, the fact that mortgages were turned into securities. Would it be better if all mortgages would be kept intact, but would then be bought and sold as is? My proposal is that Fannie Mae and Freddie Mac should be merged and turned into a nonprofit. The purpose of that organization would be to act as a mortgage broker. They would not hold mortgages, but would negotiate sales between banks or others who wanted to buy them. Banks could then issue bonds to back mortgages, but these bonds would not mean ownership." What do you think of that, Mark Zandi?

Well, I don't think securitization is the problem. I think there's a lot of benefits to securitization -- that is, bringing mortgages together, taking the principal and interest payments from those mortgages and distributing them to investors widely through a security. I think that process is a good one. I think what happened, though, is that underwriting standards came down significantly during the housing boom and bubble.

So, just to give you an example, during the teeth of the bubble -- 2005, 2006 and 2007 -- nearly half of all the loans that were originated during that period were so-called stated income loans -- that is, you could state your income. You don't have to prove your income. And, of course, that opens up a lot of room for fraud and just not telling the truth about your income, and it leads to bad mortgage lending. So, I think, that securitization itself is not the problem. It was more the fact that the underwriting standards came down. And that could be addressed and still -- it could still have securitization. And we still need it.

And to you, Michael Barr, here's another e-mail, from Kathleen, who says, "Can your guests explain the difference between the loans Fannie Mae and Freddie Mac came out -- gave out, and the loans Countrywide, Goldman Sachs, et cetera, provided to borrowers? We're always hearing Republicans pounding on Fannie and Freddie. How are they worse than the others?"

Well, I think, this points to a fundamental problem we had in our markets leading up to the financial crisis, which was a race to the bottom in underwriting standards. The basic problem started in the private market -- the private label securitization market with the kinds of institutions that your caller is referring to, and then spread to the banking sector and, eventually, to Fannie Mae and Freddie Mac. The bulk of the loans that Fannie Mae and Freddie Mac were backing were conventional mortgages that were not high-risk mortgages. But, in the height of the financial boom, Fannie and Freddie dipped their toes into the subprime and Alt-A market and then became much more involved in that market. And that really caused them significant problems.

But, really, what we need to do is address the need for a level playing field across the mortgage market for banks and non-banks, for whatever the future Fannie Mae or Freddie Mac, or equivalent kinds of institutions, is. We have to have high standards across that market. And one of the steps that has already been taken in that regard is the passage of the Dodd-Frank Wall Street Reform Act, which provides for market-wide coverage for consumer protection, which provides for skin in the game or risk retention and securitization, which provides for capital requirements across the system. And all of that is really designed so that we don't have the kind of race to the bottom that we saw in the lead up to the financial crisis this time around.

Guy.

One point that's worth making is that, you know, Fannie Mae and Freddie Mac have traditionally been in the prime market and dominated the higher quality mortgages. They've also had another role in terms of regulating lenders. They regulate servicing. They regulate underwriting. The problem is that's only one part of the market. And during the peak period that Mark is referring to, that was probably only one-third of the mortgage market. You had Countrywide to private entities determining their own underwriting, to some extent, and that was one problem.

Dina.

And on the underwriting, I think, people -- consumers, now, are feeling the backlash. Everyone's become so risk-averse. The lenders have. Fannie and Freddie have. And, now, you know, you've got to have stellar scores, big, fat down payments in order to buy a home, and so some people think it swung too much in the other direction at this point.

Now, Mark Zandi, as I understand it, you believe that there should be some kind of hybrid system between the government and private sources. Explain what you mean.

Yes. I think that the system should be largely private. But it should have a catastrophic government insurance so that, if things go very badly…

Really, really bad.

...like what we went through or what happened during the Great Depression, then the government would provide support. Now, I would argue that that benefit -- and that is a benefit -- should be explicitly priced and paid for. So it's not free. We should pay for it. But...

How?

Well, it'll be in the form of a higher interest rate to borrowers. But the beauty of this is that, because the government is involved, the extra charge to homeowners for this benefit will be quite small, so it'll keep interest rates measurably lower than they otherwise would have been. But it's still a backstop to the system.

What do you think about that form of hybrid, Michael Barr?

I agree that we need to have a government guarantee in the future. We need to have that government guarantee issued by the government, not by some private sector shareholder on replacements to Fannie Mae or Freddie Mac. And we need to put private capital in front of the government guarantee so that the government really is only stepping in for catastrophic loss situations. And the private sector is doing what it does best, which is manage normal everyday risk in the system. And, I think, we can create such a system that will bring greater stability to our financial system, greater opportunity to homeowners and will eliminate the kinds of heads, I win, tails, you lose approach that we had in the past.

Mark Zandi, I know you have to leave us at the break, so I'm going to open the phones now, 800-433-8850. First to Clemmons, N.C. Good morning, Harvey.

Good morning. Thank you for taking my call.

Surely.

I get a bit nervous when I speak on the phone like this, but referring to the problem, trying to fix the Fannie Mae and Freddie Mac thing. I'm a small residential builder in North Carolina, and I recall back in the '90s -- for most of the '90s, there was never a problem with the way Fannie Mae and Freddie Mac worked. It was primarily where most of the mortgages were generated from, and the requirements that they had were fine. And we did not have all this problem with subprime and all the rest.

This was all created with the age of deregulation on Wall Street and Wall Street coming up with all these securitized debt obligations. And they were the ones -- Wall Street was the one who started putting pressure on Fannie Mae and Freddie Mac to produce more mortgages that they could package and slice and dice and sell all over the world. So this all goes back to deregulation, which started back in the '90s and continued on. And it kept getting worse and worse during the first eight or 10 years of 2000s.

Mark Zandi.

Well, I am sympathetic to that narrative. You know, just to give you a statistic, if you go back to 2003, Fannie and Freddie accounted for, I believe, 53 percent of all the mortgage debt outstanding. That is, they either owned or they insured 53 percent of all the mortgage debt outstanding. By the end of 2006, it was down to 42, 43 percent, a drop of 10 percentage points in about three years. And that's, of course, because of the ballooning out of the private label mortgage securities market and this dramatic reduction in underwriting standards, subprime, Alt-A and all the other types of lending.

So I do think there are many reasons for this fiasco that we got ourselves into. But one of the key reasons -- I don't think the key reason is Fannie and Freddie. I think that's a secondary issue, and they got wrapped up into it at the end of the process. They exacerbated the situation, but I don't think they're the main cause.

How did they exacerbate the situation?

Well, when they saw their market share come down -- remember, they were losing all this market share. This is -- you know, they were uncomfortable with that. These are institutions that want to make money, right? So they decide, well, we need to get back in this game.

But wasn't there also pressure coming from the Congress?

Yeah, I think that's a part of the narrative, but I think that's a minor part of the story.

Mark Zandi, chief economist of Moody's Analytics. And you're listening to "The Diane Rehm Show." And to Webster, N.H. Good morning, Roy.

Hi.

Hi.

I think that the key thing that can be done to stop most foreclosures almost immediately is to restore the right of the federal judges to rewrite residential mortgages and bankruptcy. Right now, you know, commercial loans, if the market is dropped and someone can't pay it, the loans are routinely renegotiated before bankruptcy to actual market rates. Right now -- you know, it was that way until 1979 that -- you know, that reality, it's often what happened to foreclosures. But, now, millions of people are being foreclosed upon because federal judges have been denied the right to rewrite bankruptcies to reflect market reality.

Guy Cecala.

Yes. This has been an issue for the last several years that Congress has kind of avoided, and it's basically called a cram down on a mortgage. But it's allowing bankruptcy judges to lower a borrower's mortgage debt to reflect the value of the property at any given time. And, to some extent, it wouldn't be a huge change, but it's considered the start of an unprecedented intervention. And the mortgage industry's opposed it very strongly and, so far, has been successfully able to keep it at bay.

Thanks for calling, Roy. And to you, Dina, a new report out says that the size of FHA mortgages should shrink. How likely is that to happen?

Well, I think it's very likely to happen. I think that's going to be part of the proposal tomorrow, not just for FHA but for Fannie and Freddie as well. This is something we talked about at the beginning of the show. In some of the high-cost areas, including the Washington region, you can now take out a loan up to $729,750 and have it backed by the federal government, meaning, Fannie, Freddie and FHA. But, I think, what they're going to propose tomorrow is that, come Oct. 1, that that limit drop to $625,500. But some people think that it should be even smaller as far as FHA is concerned because they are supposed to serve a low to moderate income constituency.

All right. And Pat has a question for Mark Zandi. "Why are the banks not buying back the more than $100 billion in bad loans under Republicans and warranties sold to Fannie and Freddie? Presumably, they should fulfill their contractual obligations."

Well, I'm not sure precisely what she's referring to. But there is a great deal of contention around some of the loans that the banks made that Fannie Mae and Freddie Mac insured. And they're negotiating with each other to determine who should bear the loss now that these loans are going bad and that -- and I -- you know, I think the banks are, in fact, paying some money back to Fannie and Freddie 'cause they -- if they made the loans and they were badly underwritten at the time that they originated, then it -- the loss is on them. But it's -- this is a negotiation of process, and I think the banks, you know, they're -- they are paying some of the money back.

Some of the money. Go ahead, Dina.

And, I think, that's also why you're seeing the tightening of standards because the banks are so afraid now that they're going to have to buy back bad mortgages, that they are going the extra mile to make sure that they're getting the best quality loans possible so that they'll never have to buy them back.

Guy.

It's -- as Mark indicated, it's a negotiation. I think if there are $100 billion outstanding in repurchase requests from Fannie Mae and Freddie Mac -- I think last year we went through 15 billion or so. So there's a lot of it out there, and it's just a question of who's going to pay for it. There's mortgage insurance companies involved in some cases. It's not just the banks themselves. And, quite as expected, they're trying to negotiate it as low as possible in what they have to pay back.

Now, is the Congress likely to get involved there?

I don't think so. That's a pretty messy process. I mean, it's loan by loan. I mean, they are looking at each loan and saying, well, was there fraud involved? Did you -- should you have known there was fraud involved? If you did, you should pay me back.

Mark Zandi, chief economist of Moody's Analytics, author of "Financial Shock" and the forthcoming book, "Paying the Price." Short break. When we come back, more of your calls. Thanks for being with us, Mark Zandi. Right back.

And we're back, talking about what many hope will be some kind of beginning resolution to what has been the mortgage crisis dealing with Fannie Mae and Freddie Mac. Let's go now to Grand Rapids, Mich. Good morning, Nathan. Nathan, are you there? Okay, let's go instead to St. Louis, Mo. Good morning, Corey.

Panel.

Go right ahead, sir.

One of the things which really concerns me is the fact that we look at how unemployment coincided with the foreclosure rate. And there were so many blue collar workers, so many union workers, so many factory workers, people who would not be able to have the opportunity to buy a home, let alone afford one. But as these unemployment rates and as these job losses surmounted, so did the foreclosure rates mount as well. And I hear people want to restructure Fred -- you know, Fannie Mae and Freddie Mac. That might be a good thing to do, but I still hear no concession to how can we make an organization that can help working people not only get back to work, but to have the help Fannie Mae and Freddie Mac to be able to, you know, purchase houses, which is what they were here for in the first place?

Michael Barr.

I think the caller is right, that we really do need to focus on job creation, on economic opportunity, on entrepreneurship and growth in the American economy, both for its own sake and to get the housing sector back on its feet. We need to provide, obviously, unemployment benefits for those who are still having trouble, struggling to get back to work. And we need to get our businesses hiring again. So I think the caller is exactly right that investment in jobs is absolutely critical in the future.

And as we come out of the Great Recession and people get back to work, we are going to need institutions that help them get access to housing, both affordable rental housing as well as ownership. And that's really why we need a strong federal housing administration and, in my judgment, why we also need the government to stay involved in affordable housing for all Americans.

Guy.

Yes. One thing the caller alluded to was Fannie Mae and Freddie Mac's role in providing foreclosure avoidance, mortgage modifications and everything. Right now, Fannie Mae and Freddie Mac are the largest providers of that kind of services. Most loan modifications are going on on Fannie Mae and Freddie Mac mortgages disproportionately compared to the entire market. And so it's not clear whatever alternatives we come up with, whether they'll have that same type of mechanism.

Dina ElBoghdady.

Well, I think the caller hit it right on the head. I mean, it's -- the unemployment issue is the biggest stumbling block for the recovery right now. It's a problem because people can't buy, obviously, if they don't have a home. And people can't stay in the homes they've got if they don't have work. And that's the call -- the calls that I get when I'm in my office are always about the unemployment issue.

Is this leading us to a lower rate of new home ownership, Michael Barr?

I think that we're likely to see lower rates of home ownership than we saw at the peak of the boom, the financial boom. That's not necessarily bad. What we want to do is make sure that mortgage credit is available on a sustainable basis for a broad cross-section of the United States, that we have opportunities for minority home buyers, that we have opportunities for low and moderate income home buyers, that we have opportunities for working people and middle class families that's on a sustainable basis on a mortgage that they can afford and a house that they can afford, stable mortgage product that's not going to blow up in their face. And I think that's the kind of system we want to aim for in the future.

Here's an e-mail from Kristen. "What will happen to the shares of stock people have invested in Freddie Mac and Fannie Mae once the government changes occur? I ask because my current 401 (k) plan includes mutual funds with stock in Fannie Mae and Freddie. Thanks." Michael Barr.

Well, I think under almost any scenario, a transition plan for Fannie Mae and Freddie Mac equity holders and those institutions are not going to get equity out of those firms. The taxpayer stepped in to provide capital. The taxpayer is going to need to get paid back before equity holders do. I don't think that a realistic scenario would have those equity holders paid. Institutions that own debt in Fannie Mae and Freddie Mac, however, the government has made clear that the creditors of Fannie and Freddie will be protected. The owners of mortgage-backed securities backed Fannie Mae and Freddie Mac will be protected in any scenario.

Guy.

Yes. The shareholders in Fannie Mae and Freddie Mac were effectively wiped out or minimized when the government took them over, and that hasn't really changed. The stock price has gone down to, basically, pennies a share. They're not listed on the stock exchange anymore. It's faint hope to think...

Hmm.

...that they're ever going to be restored or compensated for those investments.

But Dina, Michael Barr was saying we need to keep in mind the minorities, the lower income people as they try to buy homes. But isn't this going to affect them and their ability to buy a home?

I'm sorry. Is what going to affect the elimination of Fannie and Freddie?

The new plans, the phasing out, if you will, the changes to Fannie Mae and Freddie Mac.

Sure. Sure. I mean, it could definitely affect them. And there's also -- we can't forget the Federal Housing Administration, which is the other agency that's there, you know, to back these loans. And the Federal Housing Administration's mission is to help the low to moderate income people, to help minorities, to help first-time buyers. And, right now, they're under tremendous financial strain. So what happens to Fannie and Freddie is not going to happen in a vacuum. If Fannie and Freddie disappear -- and I think we all agree there are probably -- some entity's going to replace them -- but if no entity replaces them, if Fannie and Freddie disappear, that's going to cause tremendous strain to Federal Housing Administration if the private sector doesn't, you know, step up.

You don't expect Fannie and Freddie to disappear, do you, Guy?

No. I think we're going to have to have something else. And, to some extent, we're villainizing Fannie Mae and Freddie Mac for the past and everything else. But if you look deeper than that, they have a lot of skill sets that are going to be very hard to replicate in private institutions. And, you know, some of the ones you talked about, you know, they are set up to help moderate income people, to help minority groups and other things. They have programs specifically designed from that. If we shift this to the private sector, it's unlikely that's going to happen...

Mm hmm.

...without a new legislation requiring people.

It's...

And we've already seen that happen to a large extent. Right now, Fannie Mae and Freddie Mac's business, their average credit score is, like, 760. The average down payment on a loan is 30 percent. That's not a typical starter family in the United States.

Hmm. Do any other countries offer a model by which the U.S. could re-design its program?

Probably not. In fact, you know, the United States has been an entrepreneur when it comes to mortgage lending. A lot of countries watched and came over here to see how our...

How we were doing as...

...Fannie Mae and Freddie Mac approaches. For better or for worse, they have the judgment not to replicate that themselves...

Interesting.

...and do it. And I don't think they feel bad about it now.

Let's go to Brewster, Mass. Good morning, Paul.

Yes. Good morning, Diane.

Good morning, sir.

Thank you for taking my call. Listen, I have a fourth option that I would like to throw out to your guests. And I just -- basically, it's a market solution. And it really -- it entails reviewing the lending and servicing practices of the specific lenders that are going to securitize the loans and creating a score much like the FICA score, in terms of the relative creditworthiness of consumers -- similar to that. And the second part of that is to define a oversight board for the entire mortgage market, which would basically review the practices, products, and a new ratings model, which I'd like to define a little bit -- that's the third part.

The third part is really a standardized risk-based process, which would be optionally used by the ratings companies. This, in fact, would be used to -- as a standard -- that is, it would be a process that was totally transparent, and, in fact, it would be utilized in a way in which it would be -- if I might define it a little bit -- it would be the standardized input, standardized methodology and standardized output.

Michael Barr.

Well, I think the caller's right, that standardization in the market is key. We need to have better consumer protections across the market as well. That's why the Dodd-Frank Act created the Consumer Financial Protection Bureau and a whole set of mortgage reform designed to address this issue. But, I think, it's also important to keep in mind when we talk about a fully private market, there is no golden age one can look back to and say, wow, that was, really, just a terrific private market we had.

If you think about the fully private market and the lead up to the financial crisis, that was the market that provided us with absolutely horrible practices that blew up our financial system. And if you want to find a fully private market before that, you have to go back to the 1920s, where we had five-year balloon mortgages that led us into the Great Depression. So, I think, we have to be very careful when we talk about what we're looking for in a fully private market.

But, Michael Barr, going back to that same history, when were Fannie Mae and Freddie Mac created and why?

Well, the precursor to Fannie Mae and Freddie Mac were created out of the Great Depression in the 1930s in order to precisely address the problem of creating a mortgage product and providing access to mortgages that were stable, that were good for homeowners that didn't have the attributes that we saw in the Great Depression where, if the homeowner got into trouble, you had huge foreclosure waves, very difficult ability to refinance every five years, huge exposure to interest rate risk. And the system, really, was quite unstable. So the precursor to Fannie Mae and Freddie Mac was established inside the government in order to provide this kind of stable mortgage credit.

And then in the '60s, Fannie Mae was spun out, then Freddie Mac following it in the private sector. And, I think, what we need to do, really, is bring that government guarantee back into the government, let the private sector deal with first loss risk, have the government only come in in catastrophic risk. And, I think, that's a much more stable system, one where incentives are better aligned and one where people are able to take on the risk that's right for them and not take on the risk of the whole financial sector.

Dina.

I think what's also important to remember about the Great Depression-era when people were losing their jobs left and right, again, the banks got so scared they were demanding 50 percent down payments in order for people to buy homes. And that's what gave rise to the creation of the Federal Housing Administration in 1934, and that basically redefined housing finance as we know it now. They basically said, in essence, we will make low payment loans, and we will guarantee that if those loans go bad, we'll cover the losses for the lenders.

What about the GI Bill after the Second World War? Didn't that enter in to the whole ability of home ownership and spur that movement on? Guy.

Well, we do have a active VA -- Veterans Administration Mortgage Insurance Program. It's obviously contingent on how many veterans you have at any one time and their ability to buy a home. But we've always had that out there since the Second World War. And it's an active program that accounts for maybe 4 or 5 percent of the mortgage market.

Guy Cecala, president and publisher of Inside Mortgage Finance Publications. And you're listening to "The Diane Rehm Show." Let's go now to Baltimore, Md. Michael, you've been waiting for a long time. Thanks for joining us.

I was going to address this whole issue that people are just not informed about all these things. People don't realize the role the government plays, especially in the residential housing market, that people don't realize when we're talking about railroads, that there would be no passenger railroads without government. It just wouldn't exist. Health care, you know, talking about all this nationalization, it depends how the expenditures are looked at. Fifty to 70 percent of health care expenditures are government.

Michael Barr, do you want to comment?

The caller's right that most Americans don't realize the role of government in lots of different walks of life, whether that's Social Security or Medicare or housing or job creation. The government plays, I think, quite a central role in history and the strength of our country. And finding that appropriate role for the government is one of the key debates that, I think, we're going to see playing out in Washington in the coming couple of years.

Guy.

Yes. The caller is right, particularly in the housing and the mortgage market. Currently, the government is effectively providing financing for 90 percent of all new mortgages being made in this country, and it is going to be hard. We can talk about alternatives and different approaches, but it's going to be hard to find something that's going to fill that void anytime soon.

And one last quick question from Stephanie, here in D.C. You're on the air. Please make it brief.

Yes, hi. Drawing on the title of one of your guest's books, "Paying the Price," I wonder, really, who is going to be paying the price? You were drawing on -- some of them were drawing on comparisons of -- for example, of market in other countries, which, of course, don't have fixed rate mortgages. I personally was always very cautious in buying my home and never getting adjustable rate mortgages because I wanted to have that guarantee of a security, such that I would be able to insure my own personal financial independence with some dependability.

Sure.

Obviously, if you look at those other models, it appears, to me, that the mortgage -- that the homeownership rates would obviously decline, depriving people, especially as they approach retirement, of...

Guy.

In terms of your first question, who's paying the price for it? Ultimately, it's taxpayers through the government that pays some of it, but there are investors all over the world who have paid the price, and so have financial institutions. They've taken huge losses associated with mortgages. Basically, it's all been spread out quite a bit.

And we'll have to leave it there and wait until we see what the government unveils tomorrow. Guy Cecala, publisher of Inside Mortgage Finance Publications, Dina ElBoghdady, who covers the real estate market for The Washington Post. Michael Barr is professor at the University of Michigan Law School and a senior fellow at the Center for American Progress. Earlier, you heard Mark Zandi, chief economist of Moody's Analytics. Thank you all so much.

Thank you.

You're welcome.

And thanks for listening, all. I’m Diane Rehm.

"The Diane Rehm Show" is produced by Sandra Pinkard, Nancy Robertson, Susan Nabors, Denise Couture and Monique Nazareth. The engineer is Erin Stamper. Dorie Anisman answers the phones.