Fin180

Carson Billings

Hansz

Spring 2011

The Future of the Secondary Mortgage Market

The secondary mortgage market has become an integral part of the property buying process in the United States. Ever since the system of selling mortgages, after they have been originated, was established the banking system has been running relatively smoothly. However, with all of the recent turmoil surrounding the secondary mortgage market, and the failure of some of the key players in the market, the future of the secondary mortgage market is uncertain. According to Scott Frame from the Federal Reserve Bank of Atlanta “The failure of Fannie Mae and Freddie Mac provides us with an opportunity to redefine the federal government's role in secondary mortgage markets.”

In an article written for the U.S House of Representatives, Professor Richard Worley stated “there are three options for the future of the GSEs”. The first option given was privatization or, in other words, removing all government involvement. This would effectively turn the GSE’s Fannie Mae and Freddie Mac from semi privately run, into completely privately run corporate entities. The main benefit of removing the government sponsorship from the GSE’s would be in the way people view the organization. The way they are currently arranged encourages people to believe that the government will not let them fail, even though this is not explicitly stated anywhere. According to Professor Herbert Kaufman, “they are privately owned, but the implicit government guarantee umbrella is over them, or at least the market believes that and so do I.” This implicit guarantee encourages people to make increasingly risky investments because they believe that no matter what happens they will get their money back from the government. This behavior puts all U.S citizens and taxpayers at risk for the investments of the people who invest in the secondary mortgage market.

The second possibility for the restructuring of Fannie Mae and Freddie Mac that was given was nationalization. This approach, however, would do nothing to change the fact that the public would still be on the hook paying for other people’s risky investments. Even though nationalizing these GSEs would keep them as huge liabilities to the taxpayer, some people are in favor of the idea. Thomas Stanton from the Center for the Study of American Government at Johns Hopkins University believes “that nationalizing Fannie and Freddie would force Congress to recognize upfront all the costs and liabilities of the companies.” Even if congress were to “recognize” the risks, there is no way to know if they can or will do anything to avoid burning through another American taxpayer funded bailout.

The final option is to return both Fannie and Freddie to their hybrid public-private status. The biggest problem with this option is the conflict of interests. Since they would be part private corporation, they would have an obligation to maximize profits and to do what is best for their share holders. Since they would also be part government run, they would also have an obligation to help serve the public interest regardless of what it means for shareholders and profits. Mr. Stanton believes that returning the GSEs to their previous state would be a mistake because “they effectively had two competing goals: a need to boost profits for private shareholders, and a mandate to support public policy goals.” Even though this hybrid format seemed to work well for many years, it is impossible to ignore its inherent problems.

While it is clear that the secondary mortgage market is a vital component of the American home buying process, it is difficult to foresee what format it will take on in the future. All of the options that are currently being considered have flaws and, at this point in time, it seems that there is no one right answer, and that whatever choice is made it will be because it is the lesser of the three evils.

Sources

Frame, Scott “Redefining the Scope of Government Intervention in Secondary Mortgage Markets”27 May.2010

Worley, Richard “Restructuring Fannie Mae and Freddie Mac” 3 June. 2009

Knowledge@W.P. Carey “The Privatization of Fannie Mae” 5 July. 2006

Timiraos, Nick “For a Quicker Housing Fix: Nationalize Fannie, Freddie?” 13 January. 2010 <>