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After Fannie and Freddie Go, What's Next for the Housing Finance System?

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The Great Recession has functioned like a large wrecking ball. One object of destruction has been the housing market. Price declines, loan defaults, and an unprecedented level of foreclosures have created a mess and left the housing finance system in shambles. This past Friday, the Obama Administration released its report on "Reforming America's Housing Finance Market," which was designed to start the rebuilding process.

Much of the initial anticipation has been focused on the fate of the two firms that stood in the middle of the housing finance system: Fannie Mae and Freddie Mac. With roots that extend back to the 1930s, these firms pursued a range of practices that increased the availability and accessible of mortgage financing. But their main business became underwriting the securitization of mortgages, which were packaged, sliced, and sold to investors around the world. Although they were created by the government, they were publicly traded companies that raised money in the capital markets and in turn sought to deliver profits for their investors who were comforted by the belief that the firms would have access to federal support if times got tough. The popping of the housing bubble brought on the tough times as the value of the mortgage-backed securities plummeted.

Fannie Mae and Freddie Mac have become wards of the state. Their losses are being covered by all of us collectively. Although much of the federal money distributed to stabilize the banks under TARP has been paid back (without so much of a thank you note), that has not been the case with Fannie and Freddie. They have soaked up about $130 billion, and counting, to meet their obligations.

The Obama administration made it perfectly clear in their report that Fannie and Freddie will be wound down. It is certainly a good move to resist trying to put them back together again. Perhaps we should not be so surprised that the profit-maximizing structure undermined the public mission.

But what's next for the housing finance system? The administration decided against getting behind a single proposal at this time. They put forth three distinct options for handling government's insurance role in the market. These options should and will get much scrutiny in the near future. There are real choices to be made. But what makes the report really effective is how it articulates a harsh yet sound diagnosis of what went wrong and identifies a series of principles to guide future action. Given the complexities of both the political and policy terrain that the administration needs to navigate, it's actually a pretty good approach.

Among the fundamental flaws in the housing finance system which receive significant attention in the report was the failure to protect consumers from risky, low-quality mortgage products and predatory practices. This was the building block of the entire crisis. Regulators will need to be more vigilant and empowered in the future, and the new Consumer Financial Protection Bureau will be expected to play a significant role.

The report was also realistic in its assessment that responsible reform will make credit less easily available than it once was in the recent past. This is going to magnify the importance of savings and long-term planning to the process of becoming a homeowner. Access to affordable mortgages for creditworthy borrowers will remain a goal of housing policy, and government insurance deployed in some manner to help support this process. But there is also a recognition that homeownership is not for everyone. Importantly, families will need to have choices in their housing decisions. This means we need more rental options near good schools and good jobs. The report reaffirms the administration's belief that it is the government's responsibility to ensure that all Americans have access to quality housing that they can afford. This is a necessary precondition for the social development of all families. I very much appreciate situating the housing finance policy debate within this broader framework. It is a good place to start the coming policy debate.