TCS Daily

No Place Like Home

By Duane D. Freese - April 1, 2005 12:00 AM

Mid pleasures and palaces though I may roam
Be it ever so humble, there's no place like home.

So wrote John Howard Payne in his song "Home, Sweet Home." First sung in his play Clari, the Maid of Milan at Covent Garden in 1823, the sentiment expressed has remained a constant, through Judy Garland's own immortalization of the phrase in "The Wizard of Oz" to today, when most homes are palatial by comparison to the "lowly thatched cottage" Payne praised.

For the sentiment is true: There is no place like home. The only question on most people's minds is how to pay for one.

That is the concern that should remain front and center next week when Congress holds a series of hearings into potential reform for the twin pillars of mortgage finance -- Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corp.).

The two government sponsored enterprises (GSEs) are private companies chartered by Congress to serve a public purpose -- helping make home financing more affordable to more Americans. They've been doing that not by lending directly to the public -- they are in fact prohibited from doing so -- but by creating a secondary mortgage market. They package mortgages of up to $330,000 and sell them to investors. In addition, they buy mortgages for their own portfolios.

This activity has made possible American's favored vehicle for home-buying -- the 30-year, fixed-rate prepayable mortgage. More than 80 percent of homes in this country are sold with such mortgages, a far higher rate than anywhere else in the world. As a result, American homeownership is among the highest in the world -- at close to 70 percent, with a trend of rising home ownership among people younger than 34 unmatched elsewhere in the world.

So, with a seemingly successful record, why is Congress holding hearings?

For one good reason, both Fannie Mae and Freddie Mac have experienced accounting problems in recent years. Fannie Mae is thought to have overstated earnings by $11 billion in recent years; Freddie Mac reportedly understated them by about $5 billion.

The problems have been overblown by some analysts, so-called short sellers, who make money when stocks fall. They are suggesting that not only won't investors buy the GSEs' stocks, but their bonds and mortgage securities. Other analysts have taken a more realistic view that while the GSEs' accounting errors look large, they may merely reflect technical problems in the valuation of assets and liabilities in their nearly $3.5 trillion worth of mortgage-backed securities.

Nonetheless, heads at the two publicly traded companies have already rolled, and Congress, having chartered the two companies, needs to make sure they are being well-run and appropriately regulated.

Will the hearings, though, focus on those real issues or more speculative ones?

Some critics of the two GSEs, including Federal Reserve Chairman Alan Greenspan, feel Fannie and Freddie are simply becoming too big. Greenspan told the House Financial Services Committee that while they pose no risk now to the financial system, they could, especially, in his mind, if they were to continue to add to the $1.5 trillion in mortgages they've bought for their own portfolios. He'd like to cut those down to about $300 billion.

He and others also think that Fannie's and Freddie's special relationship with the government -- such as exemption from state and local taxes and the ability to borrow $2.5 billion. They believe this creates the impression among investors that the government would bail them out if they got in serious trouble, giving them an advantage with investors over corporate bonds pushed by banks.

Last year, the Fed chairman even broached the idea that Fannie and Freddie should be totally privatized. If that were to happen, though, the question is what would that mean for home buyers?

Greenspan and other critics think not much. At the hearing in February, he said the GSEs only lower interest rates to consumers by seven basis points -- about 0.07 percent -- based on one Fed study. Whatever other interest rate advantage they have they pocket for themselves and their shareholders, according to this view.

To come to that conclusion, though, Greenspan and other critics must dismiss as an aberration the nearly 50 basis point difference between GSE securitized loans and so-called Jumbo loans not covered by the agency. They also must ignore Congressional Budget Office studies indicating a 25 to 135 basis point difference.

The differences are not inconsequential, as any homeowner paying a mortgage will attest.

The notion, though, that nothing would change if the GSEs were totally privatized seems unlikely based on conditions elsewhere in the world and from U.S. history.

If the GSEs don't matter, then how come other countries aren't offering the kind of long-term, prepayable without penalty, low down payment mortgages provided here? Why aren't people in other developed countries as well housed as here? Why do other nations spend three to four times as much on public housing? And why weren't banks pushing such mortgages long ago?

The U.S. government didn't get into housing finance as a lark. It got in because the interest of lenders was to have their borrowers carry most of the risk. Old Man Potter in "It's a Wonderful Life" wasn't the figment of someone's imagination. He was the embodiment of an era in which short-term loans with high down payments and balloon payments due on completion were the norm for the most humble abode. In troubled times, such as the Great Depression, that left many people out on the street or in so-called poor houses.

So, since the administration of Herbert Hoover, every president has made housing a priority.

From the depression until the 1970s, it was involved primarily by either paying for housing or directly guaranteeing mortgages -- so-called Federal Home Administration and Veterans Administration approved loans. Fannie Mae was created in 1938 to create a market for FHA loans. By 1970, when Freddie Mac was created to deal with savings and loan mortgages, 30 percent of all home mortgages were FHA guaranteed.

The Reagan administration reformed the two GSEs in the mid 1980s, refocusing them on establishing an international secondary market for American mortgages. FHA-backed mortgages have declined to less than a tenth of the mortgage market.

So, the question isn't whether government will be involved, it is how it can best be involved.

Congress by focusing on safety and soundness in Freddie Mac and Fannie Mae operations will promote wise involvement. If they instead chase reforms that fundamentally change the way the two firms operate they will be April fools.

For as Payne opined so long ago:

        Mid pleasures and palaces though I may roam 
        Be it ever so humble, there's no place like home.
A charm from the sky seems to hallow us there, 
        Which, seek through the world, is ne'er met with elsewhere. 
An exile from home, splendor dazzles in vain, 
        Oh, give me my lowly thatched cottage again; 
        The birds singing gaily, that come at my call; 
        Give me them, with that peace of mind, dearer than all. 
To thee, I'll return, overburdened with care, 
        The heart's dearest solace will smile on me there, 
        No more from that cottage will I roam, 
        Be it ever so humble there is no place like home.
Home! Home! Sweet, sweet home! 
        There's no place like home. 
        There's no place like home.


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