The Massachusetts Democrat laid out a series of features the mortgage finance market should have, including a limited but explicit government guarantee, strong underwriting rules and servicer oversight, secondary market access for smaller institutions and provisions to ensure the system serves a diverse spectrum of borrowers.
"We need reform, but it must be targeted reform that seeks to preserve the good things about the old, pre-crisis system," Warren said, during remarks at a conference hosted by the Mortgage Bankers Association in Washington.
Warren lauded the efforts of Sens. Bob Corker, R-Tenn. and Mark Warner, D-Va., who introduced a bill over the summer that would unwind Fannie Mae and Freddie Mac and overhaul the mortgage market, though she did not indicate that she would sign on to the proposal.
The two senators "have done a remarkable job moving the debate forward in the Senate with the bill they've introduced," she said, while acknowledging that she does not think it is a "perfect bill."
Still, her vision for reform dovetailed with the Corker-Warner approach, which calls for lenders to hold 10% of capital in a first-loss position before a government guarantee kicks in.
"It's critical to replace the implicit guarantee for Fannie and Freddie that existed leading up to the crisis with an explicit, privately financed guarantee for whatever entity or entities replace Fannie and Freddie," Warren said. "The guarantee should be expressly limited and conditioned on private capital occupying a significant first-loss position, but it must be there."
Warren dismissed the idea that the mortgage market could ever work without any guarantee.
"We have to be realistic: the housing market is so large, and so important to ordinary Americans, that there is no plausible scenario in which the government does not guarantee at least a portion of it," Warren said. "There will always be a government guarantee, and, in my view, an explicit guarantee is vastly superior to an implicit one."
She also highlighted the ongoing work of Sens. Tim Johnson, D-S.D., chairman of the Senate Banking Committee, and Mike Crapo, R-Idaho, who have launched their own initiative to draft a bipartisan proposal that will likely draw at least in part on the Corker-Warner plan.
Warren added that the "first step" in moving towards GSE reform should be examining past mistakes.
"At its core, the story of the housing crisis is a story of moral hazard for all three players—originators, private-label issuers in the secondary market, and Fannie and Freddie," she said, arguing that none had the right incentives to ensure that the quality of mortgages remained viable and that borrowers were able to pay.
She also stressed that the GSEs did not cause the finance crisis, citing a report by the Federal Reserve Bank of St. Louis, though she acknowledged that they made "significant mistakes" in their efforts to increase profits for their private shareholders.
"Their careful analysis shows that despite claims to the contrary, Fannie and Freddie's affordable housing goals were not to blame, not even a little bit, for the rapid increase in subprime originations," Warren said. "Affordable housing goals have been scapegoated b those who have been itching to get rid of the goals for a long time, but I think it's time to drop that red herring."
Warren also warned that while recent regulatory efforts, including the Consumer Financial Protection Bureau's "qualified mortgage" rule, will improve underwriting, the market could one day heat up again to unsustainable levels.
"The potential liability associated with writing non-QM loans is relatively small, and in good times, lenders can compensate for those possible losses with higher rates or fees," Warren said. "In my view, we need to consider strengthening or supplementing the QM rule so that it provides an adequate check on overly risky lending even during housing booms."
Warren also targeted servicers and trustees, calling for alignment of their interests with investors in both the government-guaranteed and private-label markets.
Additionally, Warren said any new system must ensure that the largest banks do not end up dominating the market.
"We must not end up with a housing market that crowds out smaller financial institutions," Warren said. "A housing market dominated by a handful of 'too big to fail' institutions would reduce access to mortgages in rural and poorer urban areas. It would also increase systemic risk and reduce innovation."