Professor Says CUs Should Back GSEs’ Privatization
A professor of law at Brooklyn Law School argued that credit unions should back the privatization of Fannie Mae and Freddie Mac, provided they can also ensure they get the same access to a privatized secondary mortgage market that banks would get.
The professor, David Reiss, laid out his reasoning in "Fannie Mae and Freddie Mac: Implications for Credit Unions," a research paper underwritten and published by the Filene Research Institute.
Reiss acknowledged that the easiest approach to the two now-government-owned housing giants would be to leave them more or less alone except for some reforms that would seek to uncover and address what went wrong. The benefits of backing the status quo, he says, seem obvious.
"Credit unions and small mortgage lenders would of course find this path very familiar. They would continue to have access to the secondary mortgage market through RMBS securitization and GSE portfolio purchases. They would avoid the cost, particularly the investment in new information technology, that any substantial change would impose. And they could be confident that the enormous financial institutions could not box them out of the primary mortgage markets."
But this approach would also leave CUs, along with the rest of the economy, at risk of large scale defaults again. It also would leave CUs and the rest of the country without a spur to mortgage innovation that a private and more competitive market would offer, he said.
Reiss also touches upon nationalization as an option, one which has been put forward by a number of politicians and economists. Under this option, the GSEs would be effectively merged into the Department of Housing and Urban Development’s Federal Housing Administration, which already insures many U.S. mortgages. But this approach should leave credit unions very cautious, he wrote.
"Credit unions and small mortgage lenders would have to watch the development of any such plan with the greatest of care," Reiss wrote. "Significant changes in their operations and those of their competitors could be easily worked into such a large-scale change to the housing finance system, either intentionally by lobbyists or unintentionally (as happens with all revolutionary changes to something as complex as the housing finance system). The greatest concern for credit unions would be to protect their competitive position relative to larger financial institutions."
Reiss spends more time on the privatization option that he favors, and he breaks down the option into four different approaches: privatizing the GSEs as a sort of private cooperative owned by mortgage lenders; leaving Fannie and Freddie largely intact but private, while chartering large numbers of competitors to build a broader secondary mortgage market; privatizing the GSEs and regulating them as public utilities; and, lastly, privatizing the GSEs as "financial services holding companies" much like Citigroup, J.P. Morgan and Bank of America.
The cooperative approach could attract credit union support on the grounds of a shared background, as credit unions are already cooperatives and there are already other financial institutions like the Farm Credit System and Federal Home Loan Bank system that are cooperatives.
But Reiss pointed out that the cooperative option would remain open to the possible risk of default and the need for a bailout and that the Farm Credit System required a bailout in 1987.
Credit unions might find the option of leaving privatized, reformed GSEs alone while chartering many more firms that could make up a private secondary mortgage market attractive, provided they could make sure that they had access to that market. Keeping that access might be easier, as credit unions might be able to establish a CUSO that could provide them access to that market, or a vendor interested in the higher quality mortgages credit unions have generally issued could make a niche out of them.
The approach of reforming the GSE's but then regulating them as public utilities could also attract CU support, but Reiss noted that it would require a very strong and perceptive regulator.
"In theory, appropriate regulation could help set proper pricing and control risk taking under this utility model," Reiss wrote. However, he worries that the common regulatory problem of capture would be difficult to avoid here, where the two companies to be regulated are skilled at politics and lobbying.
Finally, credit unions would likely benefit most from a fully privatized secondary mortgage market but would also need to work hard to make sure the GSEs' role as a gateway to the market was preserved.
"This path presents great risks for small retail financial institutions because they would face some increased competitive disadvantages with the removal of the GSEs and their conversion to large competitors," Reiss warned. "Without any GSEs, small retail financial institutions would have a very hard time offering long-term fixed-rate mortgages, and that would put them at a competitive disadvantage to the very large financial institutions with which they compete. Thus, small retail financial institutions would certainly want to see the GSE gateway function transferred to a new set of entities to ensure ongoing access to the secondary market," he concluded.