The private sector provides mortgages in practically every other major country with little difference between homeownership rate in the U.S. and other developed countries. The U.S. needs a new system that never places taxpayers at risk again, promotes homeownership at affordable levels, and transitions from the current model without disrupting the housing recovery taking place.
Some positive steps have been taken. Federal Housing Finance Agency Acting Director Edward DeMarco has proposed combining the back offices of Fannie and Freddie to reduce costs and increase efficiency. The merged operation would be available for use by the government or sale to the private sector after Fannie and Freddie are gone. The GSEs' huge portfolios are gradually shrinking, and Hensarling will hold hearings on what to do with Fannie and Freddie.
Yet, concern still exists among some politicians and industry participants that the housing industry cannot prosper without government support. We disagree.
The U.S. cannot afford another financial crisis like 2008-2009—a crisis that started with subprime mortgages and would never have grown so large as to threaten the whole U.S. economy if we had a market-based mortgage structure.
Subprime mortgages existed for decades. But they made up a very small percentage of the mortgage market until Fannie and Freddie reduced credit standards to gain market share and to meet low income and minority homeownership targets mandated by Congress. By 2007 nearly 50% of all mortgages originated in the U.S. were subprime and alternative-A types with Fannie, Freddie and other agencies guaranteeing about 70%, according to Edward Pinto of the American Enterprise Institute.
Without these government guarantees, the subprime bubble and the resulting financial crisis would not have happened. Bank regulators and industry experts warned Congress for decades about Fannie and Freddie and their increasingly large and risky portfolios, but Congress failed to heed the warnings.
The solution now is straightforward: abolish the public/private hybrid of Fannie and Freddie, sell or liquidate their existing business, and privatize the mortgage market.
This can be done in an orderly way in a few easy steps. Fannie's and Freddie's portfolios of mortgages should be sold at a rate of about $75 billion a year until they reach zero. The $625,000 size limit on new mortgages guaranteed by Fannie and Freddie should be reduced by $100,000 per year, so that Fannie and Freddie would be out of the mortgage guarantee business within six years. The liability for any outstanding guarantees should be managed by the conservatorship of Fannie and Freddie until they run off or are sold.
If the government still wants to be in the mortgage business for low income families or minorities, the liabilities should be on budget and transparent. The Federal Housing Administration can fulfill this mission.
Some speculate that without Fannie and Freddie mortgage rates would skyrocket and the 30-year, fixed-rate mortgage would be a thing of the past. We disagree.
Nonconventional or jumbo 30-year mortgages not guaranteed by Fannie and Freddie have existed for decades. In the decade preceding the financial crisis, the interest rate on these jumbo, nonconventional mortgages averaged just one quarter point higher than similar guaranteed mortgages, a difference of a little over $40 a month on a $200,000 mortgage. Shouldn't Americans, like homeowners throughout the world, pay an extra $40 or so per month so taxpayers aren't on the hook for hundreds of billions to bail out Fannie and Freddie? The additional interest is even tax deductible in the United States.
Some are understandably worried that this change may be too abrupt. If the market doesn't adjust fast enough after the process starts, it can be slowed so the transition takes longer.
The U.S. mortgage market should be privatized. It's time for Congress to do what it should have done decades ago and give the FHFA a clear roadmap so that it can manage the process at the lowest cost to the taxpayer and with a smooth transition to the private sector. Get the government out of the mortgage business so taxpayers are never again at risk.
Richard M. Kovacevich is the retired chairman and CEO of Wells Fargo. William M. Isaac, former chairman of the Federal Deposit Insurance Corp., is a senior managing director and global head of financial institutions at FTI Consulting, the chairman of Fifth Third Bancorp, and author of Senseless Panic: How Washington Failed America.