In 2016, an estimated 13.1 million Latino voters are expected to cast a ballot. We look at the growing influence of the Latino vote and who makes up this demographic.
In his speech on the economy yesterday, President Barack Obama described home ownership as a cornerstone of what it means to be middle class in America. Home sales and prices are rising, and fewer Americans see their homes underwater. The key now, he said, is to encourage home ownership that isn’t based on bubbles. “We’ll work with both parties to turn the page on Fannie and Freddie, and build a housing finance system that’s rock-solid for future generations,” Obama said. A panel joins Diane to discuss proposals in the House and the Senate to reform the housing finance system, whether the government should have a role and what that role should be.
- Julia Gordon director of housing, finance and policy at Center for American Progress.
- Jim Parrott senior fellow at Urban Institute and a former senior adviser on housing policy in the White House's National Economic Council.
- Alan Zibel reporter for The Wall Street Journal.
- Mark Calabria director of financial regulation studies at Cato Institute.
MS. DIANE REHMThanks for joining us. I'm Diane Rehm. A House Committee yesterday approved a bill that would liquidate mortgage giants Fannie Mae and Freddie Mac. It also limits government mortgage guarantees. A bipartisan Senate measure would replace the two companies with a new government system to backstop loans.
MS. DIANE REHMHere to talk about the future of house financing in America: Mark Calabria of the Cato Institute, Alan Zibel of The Wall Street Journal and Julia Gordon of the Center for American Progress. Jim Parrott of the Urban Institute joins us from WUNC at Chapel Hill. I do invite you to be part of the program. Give us a call at 800-433-8850, send us an email to email@example.com, follow us on Facebook, or send us a tweet. Welcome to all of you.
MR. ALAN ZIBELHi, Diane.
MS. JULIA GORDONGood morning.
MR. JIM PARROTTNice to be here.
REHMAnd, Jim Parrott, if I could start with you, explain to use your own role in terms of service at the White House in making major housing decisions.
PARROTTSure, Diane. Thank you. Thanks for having me on...
PARROTT...on the show. I was a senior adviser in the White House with the National Economic Council, which is the group in the White House that helps coordinate the major economic decisions made in the administration. They really pull together the relevant agencies on an issue and help tee up for the economic team, and eventually the president, the sort of issues of the day and how to address the challenges.
PARROTTAnd my issue was housing, and so for the last several years, I work for folks at Treasury and HUD and elsewhere in the White House to better understand the challenges that we face as a nation in housing and help the principals as it were to make decisions about what the best path forward is.
REHMAnd, of course, Fannie and Freddie have been with us for such a long time. Tell us what you believe went wrong.
PARROTTThat's a good question. So let me -- if I can first take a step back and explain a bit of what they do...
PARROTT...so we can contextualize sort of how to understand the mistakes that got us in a bit of trouble. When a lender makes a loan, they can sort of -- they can do one of two things. They can either hold the loan and collect monthly payments from the borrower, or, of course, take the risk that the borrower stops paying, or they can sell that loan to another institution that pools the loan with a bunch of other similar loans and sell securities that are backed by those loans.
PARROTTAnd then the investor is the one that collects the payments and takes the risk of default. Where Fannie and Freddie come in is they guarantee to the investors that whatever happens to the borrower, even if they go into default, the investor will get paid for their investment.
PARROTTAnd the reason why that's important and it's important to understand as we think of what to do with them going forward is it simplifies the investment dramatically so that investors don't have to understand or make guesses about the relative credit worthiness of the thousands of borrowers that sort of sit in these pools as loans which expands the investor base considerably because it makes it an attractable vehicle for investment for pension funds and sovereign funds and the like that are just looking for long-term conservative low-risk sort of revenue streams.
PARROTTAnd by expanding that base, it brings a lot more money into the system. And by bringing trillion of dollars more investment to the system, it lowers the cost to borrowers for taking out a loan because...
PARROTT...the lender can sell their loan at a premium so that they don't have to charge much to borrowers.
PARROTTSo pivoting to what went wrong to answer your question, sorry for the context, what happened basically was a system that worked relatively well for many decades ran into some trouble in the last decade when investors began to seek out increasingly risky pools of loans. They had sort of chewed through all the low-risk pools of loans and were now looking for more product. And that took them into loans that had a high risk of default. At first, Fannie and Freddie wouldn't guarantee those loans. They saw them as too risky.
PARROTTBut as a result, their market share really plummeted from around 70 percent or so in 2003 to less than or around half that in 2006. So around 2006, 2007, they made the decision that what turned out to be a fateful decision to loosen their credit standards pretty significantly to chase that market. When they did that, they did it unfortunately at a time when the market was really going after terrible loans, and they did it shortly before the market began to falter in 2007, 2008.
PARROTTSo defaults went up, losses went up, and everybody in the system who was holding credit risk, including the GSEs ran into serious trouble, so that sort of...
REHMAll right. And two points here, two points here, of course, Fannie and Freddie were both under a fair amount of pressure from members of Congress to get into those risky loans, were they not?
PARROTTYes, that's fair, but I think -- so part of the pressure is coming from Congress, but a good deal of it I think was coming from those inside Fannie and Freddie whose, you know, monetary interests was in maintaining a large market share. And when they've saw the private sector, the nonguaranteed sector double their share of the market at the expense of Fannie and Freddie, it put a lot of pressure on those guys to rethink the kind of loans they're willing to back.
PARROTTSo there was at least as much private market pressure as there was congressional pressure.
REHMAll right. So since 2008, both have been under conservatorship and now I gather they're posting really record profits like 187 billion. So it's sort of curious that right now you seemed to be seeing a move to liquidate both of them.
PARROTTYes, that there is an irony to that. The very pressures that pushed Fannie and Freddie to take on excessive risks, which is expanding their credit box to take on increasingly risky borrowers, cuts the other way pretty dramatically right now.
PARROTTSo their credit box is much tighter than it was then. And frankly, just the loans that lenders generally are comfortable making tend to be a much cleaner group of loans. So as a result with the market coming back, home prices going up and Fannie and Freddie backing a much more pristine set of loans, things look a lot better for them in the near term...
PARROTT...than they did.
REHMJim Parrott, he's senior fellow at the Urban Institute. Alan Zibel, describe the two major proposals out there to reform Fannie and Freddie.
ZIBELRight. Thanks, Diane. Well, there are two bills in Congress. There's a lot of proposals out there, but two big ones in Congress and let's start with what they agree on. Both sides agree on that there should not be Fannie and Freddie in the future. That seems to be, you know, a point of consensus that this model didn't work, which Jim talked about, you know, just how did these two companies whose stock was traded and still is traded on the stock market but the government -- the taxpayers wound up bearing a lot of the losses. That's just not a good model for the future.
ZIBELAnd both parties seem to agree there at this point. But what you've seen in the House is a very kind of philosophically pure, ideologically pure Republican approach that gets rid of the bulk of the government guarantees. It preserves the Federal Housing Administration, which is another way of providing a guarantee, but although it scales that back, too.
ZIBELIn the Senate, you have a bipartisan approach driven by Sen. Corker, a Republican, and Sen. Warner, a Democrat. And this is -- you know, if you were to guess several years down the road, you would probably, you know, be a good educated guess to -- that the ultimate solution will probably end up looking more like Corker-Warner than the House bill, which is, you know, it's more of a pure philosophical let's get the government out to the greatest extent possible.
ZIBELAnd the Corker-Warner bill establishes a new form of government guarantee without Fannie and Freddie. And really importantly, the guarantee is not on institutions. It's not -- we're not going to guarantee that institutions won't fail. We're going to, you know, have the government be sort of the backer of last resort that the securities that Jim talked about which are -- have thousands of loans in them, that investors will continue to get payments on the securities no matter what happens.
ZIBELThey have a structure and regulations and a new government entity that is, you know, kind of sets standards in this form to make sure the system works. But it is an important point that at this point there seems to be a consensus on Capitol Hill that, you know, we don't want Fannie and Freddie anymore.
REHMInteresting. All right. Alan Zibel is with The Wall Street Journal. Turning to you, Mark Calabria, why is it that some conservatives are really skeptical about providing any broad government support for housing?
MR. MARK CALABRIAWell, you know, from my own perspective as somebody I guess you could say is relatively pure at least philosophically, I don't -- I wouldn't characterize the House bill as that. I do think it does keep a very large government backing. But some of this to me is just basic economics. I mean, you know, Jim mentioned that we've created a world where the investors don't care. Well, I want a world where the investors do care because I think a world where the investors don't care is a world where you have political -- where you have these crises that come about.
MR. MARK CALABRIASo at the end of the day, somebody has to monitor the credit risks. It's not going to go away. And so the question is, who's got the best incentive? Are we going to trust Washington to monitor the credit risks? I don't think they've done a very good job in the programs that Washington monitors. So to me, this is not about some, you know, exercise in ideological purity. It's about how do you align the incentives correctly to manage risk and reduce the chance of crisis.
REHMAll right. Mark Calabria. When we come back, we'll hear from Julia Gordon of the Center for American Progress and your calls. Stay with us.
REHMAnd welcome back. We're talking about the housing market, Fannie and Freddie, what Capitol Hill is up to and what the future of the mortgage market is going to look like. Want to turn now to you, Julia Gordon of the Center for American Progress, because you issued a very strong response to what's going on Capitol Hill.
GORDONThank you so much for addressing this issue today because, in a way, this is an issue that is important for every person in the country. If you live somewhere, whether you're a homeowner or a renter, the housing finance market matters to you. And something that often happens in this conversation is we tend to talk so much about the structure of the market and about the needs of investors and how to make this the most lucrative asset class that we can that we forget that that's really all a means to an end.
GORDONThe end is providing housing to our nation's families. And to me, looking at this issue through that lens can be very clarifying. What is happening right now in the House of Representatives, as Alan mentioned, is a fairly ideologically pure -- maybe not quite as pure as Mark -- exercise in removing the so-called government guarantee from the housing finance system. And what that does is it says, all right, folks. You're on your own.
GORDONPrivate investors come and go. We saw this in the last housing downturn when we had the financial crisis. The private capital markets froze up. If we hadn't had some government-backed entities that kept the housing market going, we would've seen far bigger price declines than we had, and we would've seen a much deeper recession, you know, probably something that might even have been called a depression because that countercyclical ability was extremely important.
GORDONSimilarly, the FHA, as well as Fannie and Freddie, have long had something of a mission to make sure that a very broad group of people in this country are served by the market, not just, you know, rich people with 800 FICO scores and 20 or 30 percent down payments. And this is going to especially important going forward. You know, family formation in the next few years is going to be more than half by families of color, many of whom are low wealth and who don't have long credit histories.
REHMSo tell me what you believe would happen if one or both of these bills were somehow combined or how you think this would play itself out.
GORDONWell, one of the most important roles the government guarantee plays now is to ensure a market that enables the 30-year fixed rate mortgage. That's often called the plain vanilla mortgage product. It's been the backbone of this system...
GORDON...for many decades now. And many of you listeners have a 30-year fixed rate. And, in fact, when the housing crisis happened, you were probably really happy if you had a 30-year fixed rate mortgage.
GORDONRemoving the government backstop, which will probably lead to fewer investors who will be willing to take that credit risk that Jim talked about, and, you know, fewer investors who are comfortable with the procyclicality of the system, you'll have less liquidity overall, you know, less money in the system overall, and you will also not have the kind of homogeneity in the system right now that enables financial institutions to take on that 30-year risk.
REHMSo, Alan, the interlink bill was passed out of committee yesterday. Where does it go from here?
ZIBELWell, there, we have a fascinating question. Does this bill have enough Republican votes? Note that Democrats are very unlikely to vote for it. Does it have enough Republican votes to pass the House floor? And that breaks down into a really kind of big picture political question. Where's the Republican Party at right now?
ZIBELIs the Republican Party, you know, turning more Libertarian, turning in -- becoming more focused on, you know, what it wants, what its sort of Libertarian thinking folks want and kind of turning away from the traditional big business allies? I mean, a lot of people in that party would say that's a good thing. We're not here to do what business wants us to do. We're here to do what we think is right. But you got very powerful business interests that want that government guarantee.
ZIBELYou've got the realtors. You've got the homebuilders. You've got the mortgage bankers. You know, my sense is, from what I've heard, you know, that this is going to be a key issue for them. They're going to look at their donations, their campaign spending and say, hey, you know, this is our key issue. You're not voting for us. Sorry. You know, we're not donating to you anymore. I mean, and that a pretty big deal, and that could mean a lot.
CALABRIAYou know, first, I want to very much agree with Julia that the -- that, you know, the investors, that's secondary. We should really be judging this by what has been the success of the system. And here's where I'll depart from Julia. So a little bit of history. We really didn't have a secondary market and mortgages until about the 1980s. Freddie was created in 1970 from about even Fannie in the '30s -- from the '30s until the '80s, the market share of these GSEs were in single digits.
CALABRIANow, if you look at the homeownership rate, we got to about 64 percent in 1960. Since that time, we have volatile around that, but we haven't increased the long-term homeownership rate since that time. I'll also note the -- over the last hundred years, the difference in African-American and Caucasian ownerships has decreased by one percentage point.
CALABRIASo I would argue, if you really look at the system and say, what has is delivered, it hasn't delivered homeownership. It hasn't delivered affordability, mortgages who are actually cheaper relative the treasuries before the creation of the secondary mortgage market than they are today. So it's very hard to look at the aggregate data and say, what have we gotten out of this?
REHMBut let me ask you, Mark, do you see any role for the government in providing any kinds of specialized loan especially for homes?
CALABRIAWell, OK. In an ideal world, I would have no intervention at all.
CALABRIABut we are not in an ideal world, and I think it's important to keep in mind there are a variety of interventions. It was mentioned Fannie and Freddie were there during the crisis, but they were only there because the Federal Reserve bought $1 trillion to their debt. The Treasury underwrote their losses. You know, if the Federal Reserve went and made a market in Wells Fargo debt, Wells Fargo would've bought $1 trillion in mortgages too.
CALABRIASo nobody's talking about it, apparently ending the Federal Reserve's ability to buy mortgage-backed securities. So I want to emphasize, we have a variety of backstops, the Federal Home Loan Banks, Ginnie Mae, FHA. Fannie and Freddie are a small piece of this. They grew very large. You could take them away, and there are a variety of other backstops. Now, we do need to make sure that that risk doesn't just flow to other institutions that are also backed by the government.
REHMJim Parrott, are those institutions sufficient to sort of step in where Fannie and Freddie have been?
PARROTTI don't think so 'cause I think what you'll see -- if you see a movement to pull Fannie and Freddie out altogether, you'll also see a movement, as you see in the House, to really cabin in the market share of the remaining institutions. I don't think there are many folks out there that would argue that you would want FHA and the rest given the way their risk is managed to take on what Fannie and Freddie have taken on traditionally.
PARROTTI think most folks that think -- I think Mark probably would agree with this -- that if you're going to have a government backstop, it's better to insulate it behind a bunch of private capital in a way that FHA isn't today.
PARROTTSo if you're going to -- if you start from the premise that there should be a broad government guarantee, which is up where Mark is, I think from there, you wind up in where the sort of Senate is, which is, how do you structure that guarantee in a way that that cleans up a lot of the flaws that we had in the (unintelligible) ? And I don't think the answer -- if you're starting from the premise that we need a broad government guarantee is, patching together the residual backstops to replace Fannie and Freddie.
REHMSo how could a change to our system of financing mortgage loans affect what people are calling a current housing recovery, Jim?
PARROTTThe pacing of all this is going to be quite important. I think as Alan mentioned, it's important that as we look at the two sides of the debate that we recognize that there is commonality in what the next several years should look like, that is there's a common view that whenever you think about what the world should look like in 10 years, one agrees typically that over the next three years, you need to begin to scale back Fannie and Freddie and FHA to bring more private capital in, more non-guaranteed private capital in.
PARROTTAnd as we see that happen, whatever one thinks about the end state now, we'll learn a lot about what the private market is really capable of doing in taking on this sort of new credit risk. If it turns out that the Marks of the world are right and we see a robust market that's as robust as we as a nation want and that provides a kind of long-term fixed rate lending that we want, then there's a strong argument to keep, you know, gradually winding down that footprint until the private market seems unable to take on the liquidity and provide the lending that we need.
PARROTTIf, on the other hand, we hit a point where the private market seems unable or unwilling to provide the kind of lending that we as a nation decide we want, then it would seem the wiser course to hit pause and wait and see. Part of the problem right now and the debate is it's wildly theoretical, with both sides talking about what this hypothetical world is going to look like in 10 years.
PARROTTAnd rather than roll the dice on a $5 trillion market on who's right, it seems to make sense to gradually turn the rheostat down, pull the government footprint back and see what happens on the private sector side, and then we'll be a bit better informed to make a decision.
REHMSo, Julia, what you're worried about is seeing all of this mortgage financing going into the hands of Wall Street?
GORDONRight. I think sometimes we can romanticize the private capital markets. I remember, as Alan mentioned before, in the lead-up to the crisis, it was the private-label mortgage pools that led us down the path to ruin, frankly. You know, it was their hubris, frankly, that they had conquered the problem of risk and essentially eliminated risk while what they were really doing was creating this risk-loaded Ponzi scheme that eventually fell and, you know, caused the financial crisis that we had.
GORDONSo, you know, I don't want to denigrate -- private investment is the core of the system. Something people forget is that all of the money in the mortgage market is private money right now. It has a guarantee, which now is somewhat more explicit than implicit. But these are your pension funds that are investing, you know? These are important investments, but there needs to be a backstop.
REHMSo what do you think would happen if Fannie and Freddie went down?
GORDONI think what will happen is you would see a smaller market. You would see less access to credit. The 30-year fixed rate would be much less available. It might still exist in some places, but really only for the most pristine of borrowers.
REHMAnd you're listening to "The Diane Rehm Show." And, Alan, it does seem as though with the profit that Fannie and Freddie are turning right now, it seems a curious time to be thinking, let's roll them out.
ZIBELI think that's true. The irony is there, as Jim noted earlier. And, you know, one of the criticisms that's been sort of leveled at the administration -- and I think really both from the left and the right, and maybe some people on the center -- is that they, you know, they've allowed the situation to develop by not being more kind of aggressive and specific about what should be done.
ZIBELI mean, it's something that maybe Jim could respond to, but, you know, they did do a paper in 2011 that laid out three options. You know, the president had a very kind of quick mention of it yesterday, nothing specific. But that -- I've heard that from folks on both sides of the aisle. You know, why can't we get more out of the administration on what they think should be done?
CALABRIAThat's a very good point. We aren't seeing any effort by anyone, really, to do any sort of scale-down.
REHMExcept the president did talk yesterday about the real estate market.
CALABRIAI know. He did talk about it. He's talked about it a number of times. There would need to be some action at some point. But I want -- there's a couple of issues I want to address. We do see the 30-year mortgage readily available even to subprime borrowers in the jumbo market. The data...
CALABRIARight now the data support that. The contraction in low down payment lending was both across Fannie and Freddie as well as the jumbo. But, you know, I don't...
REHMHold on a minute there because Julia seems to have a different perspective.
GORDONSo that is often the response is that, well, the jumbo market provides us. But remember, the jumbo market is actually defined by its very existence outside this existing conventional Fannie and Freddie market. The jumbo market, the players in that can hedge using the conventional market. They...
REHMSo you're saying...
GORDON...rest on the processes and standardization of the conventional market. If it all went away, it's not at all clear that the jumbo market would look like today's jumbo market looks.
CALABRIAWe had a mortgage market before Fannie and Freddie existed. We had a mortgage market before they had much of a footprint. Now, I think, to me -- and I want to make another point. It's often put about that, well, this is just the banks gaming. Let's be clear. If the banks wanted to get rid of Fannie and Freddie, they could do it today by boycotting Fannie and Freddie.
CALABRIAFannie and Freddie could only buy loans from the banks. So at some extent, what Fannie and Freddie are essentially are is a vehicle for the banks to transfer the risk to the rest of us. That's what it is. They dump the risk to the taxpayer via Fannie and Freddie. I would prefer the banks have to bear that risk themselves rather than force it onto me.
GORDONRight. The problem is then we end up bailing out the banks as we did this last time around. And, you know, as you'll recall, the TARP bailout, the vast, vast, vast majority of that money ended up bailing out the banks in Wall Street, very little money to Main Street, and I'm just worried that we're headed in the same direction.
CALABRIAIf I could be quick, I was against all the bailouts then. I'm against them now. My back of the envelope is that if all of these mortgages had been held by the banks instead of Fannie and Freddie, we'd have had over 200 billion more in capital in the system. So the question has to be -- I mean, I don't really like Wells any more or less than I like Fannie.
CALABRIABut Wells has a whole lot more capital behind their loans than Fannie does. So part of this needs to be do we want to set up a system where the risk essentially flows to where there's no capital? Because that's what Fannie and Freddie were. Their guaranteed business was leveraged 200-to-1.
GORDONRight. And nobody wants to set that up again. That was a bad idea.
CALABRIAEverybody loved it at the time.
REHMAll right. Here's a question lots of listeners are asking: As these are publicly traded companies, how will their stock shares be handled if the companies are put out of existence? Alan.
ZIBELI think the administration has been pretty clear on this point that there's very little likelihood of any payout to stockholders of any kind. They've been pretty clear that investors in bonds do get paid, but not the shareholders.
REHMAlan Zibel, he is a reporter with The Wall Street Journal. When we come back, we'll open the phones, take your comments, questions. Stay with us.
REHMAnd welcome back as we talk about the housing market bills in Congress, one of which would eliminate Fannie and Freddie. And here's our first email from David in Boca Raton, Fla. saying, "Why should we trust Congress to manage this problem with legislation that favors the commercial markets, removes government oversight and further deregulates an industry that's proven to be willing to put profit far ahead of prudence?"
REHMDavid goes on to say, "My perception is that the money industry has too much influence. This has resulted in little or no regulatory restraint on the housing industry." Jim Parrott, how do you feel about that?
PARROTTYou know, it's -- I'm not sure how to respond. I guess, in either case, whether you wind down Fannie and Freddie and replace them or not, so under either side of the argument, the system is going to be driven by the private sector. It's going to be driven by decisions around risks made by lenders and issuers and the like. And so either way, you're going to need a relatively strong regulatory scheme setup to make sure that incentives are aligned and that, at the end of day, taxpayers aren't on the hook for excessive risks.
PARROTTSo, I think, we face that sort of challenge in either case. One, I think, as Julia has, can argue persuasively, I think, that we're more exposed to, sort of the indiscretions of the bubble in the private sector in the absence of a broad government role. But either way, you're, in the absence of strong regulation, which arguably Dodd-Frank begins to provide, going to be exposed to decisions by the private sector because, frankly, that's the sector that drives liquidity in the space arguably at it should.
PARROTTI think the answer is not to pull back on leaning under the private sector, to drive liquidity in the space, because they're the most efficient outfit to provide lending. It's more a matter of how we provide a structure of oversight and make sure that the incentives are aligned in a way that doesn't lead us down the path we took before.
GORDONI'm leaving aside the relative merits of Congress, which, you know, we're stuck with. What is important to remember about Fannie and Freddie as well as FHA is these entities have always had an explicit public purpose. That is, in return for what -- for the goodies they get by having the backing of the government, they make a promise.
GORDONAnd that promise is that they will try to have policies and programs that serve the, you know, vast majority of the country. Again, Fannie and Freddie are not just there for single-family homes. They also support rental housing. So really everybody who needs affordable housing is touched by them, and when you leave this entirely loose to the private sector, you know, there's no such promise there.
REHMAll right. Let's got to Raleigh, N.C. Hi there, Frank.
FRANKYes. Good morning. I would advocate for the dissolution of both Freddie and Fannie. All of this stuff sounds fine in theory. But life is not theoretical, and I will give you a perfect example. I lent money to a co-worker when we were both employed by a wonderful company that had a fantastic credit union. Well, I lent the guy the money, and he stiffed me on it. And I had to take him to small claims to get it back. My stepmother was an accountant and a bright woman. She pointed out to me that if this guy was a good credit risk, the credit union would have lent him the money.
REHMAll right, sir. Thanks for calling. What do you think about that, Alan?
ZIBELI do think that there's, you know, in any kind of loan, there's always a risk that the bar were to fall, you know, in hard times. I mean, that is something that always happens. On the previous caller, I wanted to point out that, you know, some of these, you know, policy weeds are being figured out by Congress. Some of it is being delegated to federal regulators who are a key part of Dodd-Frank.
ZIBELThe financial overhaul law from three years ago gave the new Consumer Financial Protection Bureau to basically set kind of a baseline, you know, parameters for mortgage lending across the country. And those go into effect in January. And, you know, any -- the lending of the future is basically going to have to follow that. So that's going to be out of Fannie and Freddie's hands in a couple of years.
CALABRIAYou know, the common theme between these last two questions to me was prudence. And so my concern is that when the government comes in and guarantees credit risk, and as Jim mentioned earlier in the hour, you know, a system where the investors don't care, then you reduce the amount of prudence that investors demand. You reduce the amount of prudence that market participants demand upon each other. So the real question is here, can we trust the regulators to substitute for the erosion -- disappearance of market to support in the mortgage market?
REHMBut the opposing question to that is, can we trust Wall Street?
CALABRIAWe can't trust anybody. So the question needs to be, how do you make the right incentives? I mean, nobody is a guide of their -- a judge of their own actions whether it's the president of the United States or president of a company. There always has to be offsetting incentives within the system where people monitor each other.
CALABRIAAnd so the way companies work in a market that does work, which we don't have, is that when you take riskier activity, when you're reckless, mismanaged, corrupt, people charge you more to lend you. But the thing about Fannie and Freddie is the more corrupt they were -- remember, these were two largest financial statements in history of reinstatements.
REHMI think a lot of people would argue with your use of the word corrupt.
CALABRIAThere was a counting fraud proven at Fannie Mae to gin up bonuses. That's a fact. I'm happy to cite -- I'm happy that these are very large...
REHMAnd, Jim Parrott, would you agree?
PARROTTWell, what I would say in response to that, and I was about to chime in anyways, is I think everyone would agree with the premise that Mark has laid out, which is you've got to make sure that there is private capital on the hook for the risk in the system to make sure that incentives are aligned all the way through so that you don't have folks on the front end of the system making loans they shouldn't make and then turning them over to investors who purchase them with indifference to the risk.
PARROTTIf you don't have people that are in a sense that have skin in the game all through the system so that if a bar -- a pool of bar is default, those folks, in some sense, suffer the cost, then you don't have the right kind of internal private market-driven oversight of the system. I don't think anyone actually argues against that.
PARROTTThe question is whether or not after you wind down Fannie and Freddie, you build out a system that has private capital -- a bunch of private capital ahead of a government backstop, a bunch of private capital at risk ahead of a government backstop, whether or not that for whatever reason is a superior system to one in which the backstop is not at the back, I don't think anybody is arguing that we don't want to have incentives align correctly, that we don't want to have private capital on the hook in such a way that there are many eyes on the credit risk involving the system.
PARROTTThe question is, one, in a sense of design, what's going to give us the most liquid market that provides the kind of products that we think we, as a nation, need at, you know, moderate if low risk to the taxpayer at the end. That's a design question.
REHMAll right. Let's go now to St. Louis, Mo. Clifton, you're on the air.
CLIFTONYes. I just want to associate myself with Julia's comment, but I want to say that the mortgage crisis was primarily a failure of regulation. The private-label securities market that was created by the subprime lenders, who were the Wells Fargo in cities, the J.P. Morgans of the world that took bad plain vanilla 30-year mortgage and made it into private-label securities at just a 60 percent of the $8.5 trillion market is what created the problem.
CLIFTONThey were not regulated, and yet they made a mistake in not regulating Fannie and Freddie. The other thing I would say to you is that the -- to turn this market over to a Wells Fargo is give a flawed idea. Fannie and Freddie exist, FHA exists because these banks are spending short term in a 30-year mortgage is a long-term investment.
REHMAll right. Thanks for your call. Julia.
GORDONThank you so much for those comments. I think it's important to note that regulation or some kind of oversight is another aspect of what helps make the system work for everyone. You know, Mark talked before about prudence, but, you know, Mark probably has health insurance. And I don't know if having health insurance causes him to be more or less reckless when he's driving down the street.
GORDONBut what it's there for is so that when he, you know, if he goes to the hospital, he has the insurance. We don't have to, you know, pay for him as someone who's not insured. And that we're just trying to – this all secondary market jargon that we're basically talking about insurance that, ultimately, keeps us all safe. And like any other insurance, the secondary market insurer doesn't pay if there is, you know, fraud in the origination of the mortgage. This is insurance against those things that we know happen in life all the time.
REHMAlan, is there anybody who's arguing that Fannie and Freddie should stay on the block, but with some tweaking?
ZIBELYes. Actually, there is. I mean, there's a view out there -- I don't believe this is shared by the administration or by most in Congress. But there's a view out there that we should take Fannie and Freddie, spin them back out as private companies, regulate them a bit differently. And there's a view that some of the investors, you know, if the privates continue, could get paid.
ZIBELSo -- and there are people on Wall Street hedge funds making that bet right now. It doesn't seem like that is a mainstream view, but there could be legislation in Congress coming forth to this effect, and there are some people out there who support it.
REHMAll right. To Jasper, Ala. Hi, Lita, (sp?) you're on the air.
LITAYes. Good morning. My question has to do with the problem with Fannie and Freddie -- Freddie and Fannie originating because in the late '90s or early 2000, Congress changed them into a quasi-public form. And before, they were public, then they became quasi-private, and the incentives changed for the executive. And that made them do a lot of what happened later on. They were market-incentivized instead of incentivized for our common good.
REHMJim Parrott, would you agree?
PARROTTI think most would actually agree that the incentives of Fannie and Freddie, especially through the bubble, were misaligned. You had what you often hear, say, private market gains at the expense of taxpayer risk because the public perceived and investors perceived, rightly as it turns out, that the government would step in and backstop these entities if they went south.
PARROTTAnd so I think -- what I think everyone would agree is that if you were to replace them with some other government guarantee, you've got to make sure that you don't have this sort of mix of incentives so you've got folks that are able to take heightened risk for their own benefit, knowing that in a sense that tail risk is covered by the taxpayer. I think the caller is right that the incentives were misaligned, and that's one of the core things that Congress is probably going to struggle to fix if they decide to replace it with another government backstop.
REHMJim Parrot, he's senior fellow at the Urban Institute. And you're listening to "The Diane Rehm Show." Let's take a call right from here in D.C. Hi there, Robert.
ROBERTHello, Diane. Thank you for taking my call.
ROBERTDiane, I'm a shareholder in Fannie Mae, and I bought my shares prior to the collapse. So I'm telling you, I'm not speculating in the stock. And I believe that one of your guests has probably hit on an excellent solution, would be just once Fannie Mae has paid back the federal government, the federal government needs to return the rights to its shareholders because right now Fannie is in conservatorship. It is not in bankruptcy. The federal government does not own it. And the Congress has to realize that we, as a shareholder, still own the company and our rights need to be protected.
ZIBELThe point on that that I would make, as the caller notes, I mean, there are people in the market that are making this case, and they're making this case in court. I mean, there are couple lawsuits out there by very, you know, large investors in holdings of Fannie and Freddie. And their -- that issue could ultimately be decided by the court. But the Treasury is pretty firm that, you know, they have the right to buy 80 percent of the shares of these companies. They can do whatever they want and not pay the shareholders. So that's their position, and it'll probably be decided in court at some point.
REHMSo, Jim, back to you, where is all of this headed? Will any of this legislation lead to some kind of reasonable solution?
PARROTTI think that's, at this point, the $64,000 question. I think the majority of folks in Congress and certainly the majority of those who have the year of Congress right now would probably -- if they had their druthers land on something in the general vicinity of where Sens. Corker and Warner's legislation have leaned. But the House of Representatives and Chairman Hensarling feel very differently about the long-term fate of the system and ultimately, in some sense, hold a blackball vote in how all this goes.
PARROTTSo the question is going to be whether or not the House will agree to compromise at the end. So the way this would play out -- if you were to see reform before the midterm say or legislation for the midterm say -- would be you get legislation out of the Senate. You get some version of what Chairman Hensarling has proposed out of the House. They get into conference and negotiate out some settlement in which, you know, maybe the House asks for a faster wind down of Fannie and Freddie. And maybe they ask for a repeal of some of the Dodd-Frank provisions that they are pushing for.
PARROTTAnd maybe they push for a smaller government footprint. But at the end of the day, they'd give on the bigger question of whether or not there is a government guarantee at the end. And so, really, the question of whether or not we see legislated reform depends on whether or not they make the strategic decision to compromise for something that would be a sort of right-of-center compromise, frankly, or whether or not they remain pure and somewhat ironically hold us all in the state that we're now, which is a nationalized market.
REHMMark, where do you think we're going?
CALABRIAUnfortunately, I largely agree with Jim on this. While I would like to see a privatized market, I think the odds are we'll continue to have very large backstop. I think within my lifetime, I will see another very large taxpayer finance bailout of the housing market.
GORDONI would also add that, as Jim mentioned, what's ironic now is while the more ideologically pure folks try to get all of the government footprint shrunken down, the market is effectively nationalized right now. And it's not in a static state encased in Amber. There is an agency, the Federal Housing Finance Agency, who's the conservator for Fannie and Freddie that right now holds all of the power, really quite independent even from the administration because there's not a confirmed director.
REHMJulia Gordon of the Center for American Progress, Mark Calabria of the Cato Institute, Alan Zibel of The Wall Street Journal and Jim Parrott, a senior fellow at the Urban Institute, thank you all so much. And thanks for listening. I'm Diane Rehm.
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