This Tuesday, August 17, the Treasury will host a conference on GSE reform, entitled "The Future of Housing Finance."  In evaluating the opinions and media coverage sure to emerge from this event, voters should consider four key issues:

1.  How much housing is too much?  Policymakers have long favored housing, arguing for example that homeownership promotes stronger communities.  No doubt, policy reflects voter preferences.  Indeed, many regard housing as a component of the "American Dream."  However, some people do not have the financial resources for homeownership, and when they were lured into buying houses with risky mortgages, the result was a collapse in the mortgage and housing markets that was arguably worse than what happened in the Great Depression.  Too much housing morphed the American Dream into a nightmare; we need to decide upon the right level of government subsidies.

2.  How big should the government be in mortgages?  The government is currently originating something like 9 out of 10 new mortgages, by virtue of the FHA, Fannie Mae, and Freddie Mac.  Shouldn't the private sector play a bigger role?

3.  How much risk should we take?  Fannie Mae, Freddie Mac, and their cousin the Federal Home Loan Bank System have issued close to $3 trillion in debt.  In the old days, when they were profitable and had solid (albeit thin) equity cushions, this debt could be regarded as "off balance sheet."  But not today.  Fannie and Freddie have -$3 billion in equity, even before considering the $80 billion in preferred stock owned by the government.  Any accountant would consolidate their debt on the US government's balance sheet.  Doing so would push the ratio of government 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) can be a source of Black Swan-like volatility.  If we want to avoid this volatility, we should think about how to pay down Fannie and Freddie's debt, which likely requires putting the firms into run-off.

4.  How do we transition to a new model?  At present, the US housing market is addicted to government subsidies.  If you took out the government, you would lose 9 out of 10 new mortgages, and the housing markets would promptly collapse.  What the addict needs is something like methodone, which helps to break the habbit without kililng the addict.  I and others have suggested that Fannie and Freddie's useful function, that of guarantying mortgages against default so as to create highly liquid mortgage-backed securities, should be transferred to the private sector.  This could happen by allowing large banks to bid for the right to issue mortgage-backed securities.  Or perhaps by forming a cooperative, owned by the banks, that would issue these securities.