An article written for the Journal of Applied Corporate Finance, Morgan Stanley Publications.

Click here to download the pdf by Kenneth A. Posner.

Download the presentation, Bookmarks Festival, September 11, 2010.

This coming Tuesday, 8/17/2010, the Treasury will host a conference on GSE reform entitled "The Future of Housing Finance."  In evaluating the opinions and commentary that this event is sure to generate, taxpayers and voters should focus on three issues:

1.  How much housing is too much?  US policymakers have long promoted housing as a component of the "American Dream," arguing for example that homeownership helps form stronger communities.  No doubt these policies reflect voter preferences: it's no accident that Fannie and Freddie were formed to help maintain liquidity in the secondary mortgage markets, that mortgage interest is tax deductible, and that the FHA helps low-income borrowers buy homes.  However, the Great Recession was sparked by the collapse of the mortgage and housing markets.  Somehow housing became an "American Nightmare."  We've seen that trying to encourage too much housing becomes counterproductive, so we might want to think about scaling down governmental subsidies to more realistic levels.

2.  What's the right amount of government involvement in housing?  Today the government, acting through Fannie Mae, Freddie Mac, and the FHA, produces something like 9 out of 10 new mortgages.  Shouldn't the private sector play a bigger role? 

3.  How much cost and risk should we take on in promoting homeownership?  Fannie, Freddie, and their cousin the Federal Home Loan Bank System have issued almost $3 trillion in debt, but it is considered "US Agency Debt," not direct obligations of the US government.  In the old days, when the companies were profitable and had solid (albeit thin) equity cushions, their debt could be considered "off balance sheet."  But not today.  Fannie and Freddie's equity capital was -$3 billion as of second quarter 2010, and that's not counting some $80 billion in preferred stock owned by the Treasury.  Any accountant would consolidate their debt on the US balance sheet, which would push the ratio of US debt to GDP from approximately 100% to 115% .  As I point out in "Stalking the Black Swan," off-balance sheet debt (and other forms of hidden leverage) increase risk, making Black Swan-type volatility all the more likely.  If we don't want this volatility, it would make sense to run down Fannie and Freddie's large portfolios and pay off this debt.

4.  How do we transition from the current model to something new?  Unfortunately, the US housing market is addicted to government subsidies right now.  If we went "cold turkey," i.e., shut down Fannie, Freddie, and the FHA, which are currently producing 9 out of 10 new mortgages, then the housing markets would essentially collapse.  Rather than cold turkey, we need the equivalent of methodone, something to ease the addict off of his habit, without killing him in the process.  One idea would be for Fannie and Freddie's useful function (that of guarantying mortgages) to be transferred to the private sector, so that the mortgage market does not lose the benefits of having highly liquid securities in the secondary markets.        

By Kenneth A. Posner

Recently, the U.S. Financial Crisis Inquiry Commission (FCIC) held hearings on the role of the rating agencies in the near-death  experience of the U.S. financial system, an important topic given the disastrous performance of mortgage-backed securities rated AAA by Moody’s and Standard & Poors. The problem with the rating agencies is not their role, but the oligopolistic domination of the business by these two firms.

By Kenneth A. Posner

It would be nice if we could predict bubbles; even nicer if we could prevent them. Unfortunately, this would violate the laws of nature: asset bubbles occur because of the limits of our ability to process information and coordinate activity in a market setting, where no-one is in charge, and no-one has a complete view of the big picture.

By Kenneth A. Posner

In a recent Huffington Post piece, "Planning for the Unimaginable," Terry Newell asserts we must get better at planning for and reacting to so-called "Black Swans" (the term popularized by Nassim Taleb for seemingly unpredictable extreme events). To do so, Newell recommends that we "institutionalize thinking about the unimaginable." Newell's attitude is refreshing. Volatility is the result of market economies, global capital flows, and ever more powerful information technology -- and thus a price we pay for innovation and growth. Better that we learn to live with it, than try to wish it away.

By Kenneth A. Posner

Recently Alan Greenspan has been blamed for cutting interest rates too low, thus fueling the US housing boom and bust, an assertion he partially acknowledges. Yet he was the "maestro", America's most widely respected chairman of the Federal Reserve, during an 18-year term.

Kenneth A. Posner

In its own eyes, Goldman Sachs is the world’s premier financial institution, doing what CEO Blankfein calls 'God’s work.' The SEC lawsuit is inconsistent with that self-image, and Goldman is struggling to adapt.

Kenneth A. Posner

This appeared as the lead article on the website of American Banker and in their email newsletter, April 8, 2010. It also appears in print and online at Investment Dealers Digest.