The house that mortgage debt built.

By Jim Boswell, author of Crush Depth Alert

Tomorrow the Secretary of the Treasury is holding a conference to begin deciding what to do about the Government Sponsored Enterprises that we love to call Fannie Mae and Freddie Mac. As someone who is considered an expert in the risk of “housing finance” and “mortgage-backed securities”, yet not invited to confer at the conference, herewith is my own separate recommendation on what to do about the GSEs and the reasoning that goes with it.

Before beginning as background for my claims, I would like to mention that I have both an M.P.A. degree and an M.B.A. degree from top nationally-ranked U.S. institutions. For a twelve-year period (1988-2000), including the full period of the S&L crisis, I directed the activities of a staff of about fifteen whiz kids in my position with PricewaterhouseCoopers where we designed, developed, and then monitored the risk systems used to oversee the risk of Ginnie Mae’s portfolio of mortgage-backed securities. In 1995 I received a Vice-Presidential achievement award for that associated work. And for the last ten years I have been trying to warn the powers-to-be about the risk of the GSEs to no avail.

The solution that should come out of the Treasury conference is the abolishment of Fannie Mae and Freddie Mac and the entire concept of Government Sponsored Enterprises in the process. The GSEs were asked to serve two masters (the public welfare and their stockholders) at the same time—and essentially failed both.

Mortgage debt in the United States (currently more than $10 trillion) has grown to the point that it is nearly the same size as our national debt (in fact, a few years ago, U.S. mortgage debt actually successfully passed our national debt), and it has only been as a result of the new Administration’s debt spending that our national debt has regained the lead in the race to see which can account for the highest amount of our economic debt.

Regardless, it is important to understand how mortgage debt affects our economy and how it is different than national debt (like apples and oranges) in at least three significantly important ways.

First, American homes act as collateral for mortgage debt. No such similar identifiable set of fixed assets are associated with our national debt as collateral.

Second, both principal and interest on Mortgage debt is paid monthly through homeowner monthly statements. National debt, considering our deficit spending, is not paid at all even with taxpayer funds. Currently, our Federal budget is so out of balance that it can be said that even the interest on our national debt has to be covered by increasing our national debt further.

Third, a change in the average mortgage rate today affects the value of every house in America today. As mortgage rates are lowered, housing becomes more affordable, thus driving up housing prices, and vice versa when mortgage rates are raised. Although changes in “short-term” Fed funding and Treasury rates affect investment decisions significantly, it is arguable that a similar unit change in our country’s mortgage rate affects our economy even more—and there is absolutely no argument that a change in mortgage rates affects our economy more than a similar unit change in “long-term” Treasury rates.

In other words, because of the more than $10 trillion of mortgage debt in the United States, it is important that we do not treat it with a lackadaisical “laissez-faire attitude”. If you believe in the Federal Reserve’s role in establishing rate policy for economic purposes, which I fully understand is a debatable issue on its own right, then you should also believe that someone with similar power should establish a consistent and well-reasoned policy for mortgage rates. In the past we have failed to do that in the United States and this, believe it or not, as much as anything else, is why we are currently living through the Greatest Recession Since the Great Depression.

Now moving forward this is what needs to be done. All the current activities and obligations of Fannie Mae and Freddie Mac should be combined with those of Ginnie Mae, the FHA, and the VA into a new Federal Agency called something like the Federal Home Loan and Security Corporation. At the present time this new agency would account for approximately one-half of the mortgage debt in the United States with the other half being handled by the private sector banks.

This new Federal Agency should only be allowed to issue new loans for a limited value (e.g., under $500,000) for the “primary home” of an American citizen with appropriate certifiable credit status. All loans and securities issued through this agency should carry with it the Full Faith and Credit Guaranty of the United States of America behind it. In the process of forming this new Federal entity, the combined staffs of all associated entities should be reduced by at least one-half and close to two-thirds. A new state-of-the-art underwriting system should be designed to assure fiduciary responsibility.

The President should choose a real financial wizard or czar to head the new agency. The Congress should confirm this individual using a similar process as used to confirm a new Chairman of the Federal Reserve or Treasury Secretary. The Federal Mortgage Chairman (or Secretary) should be given the responsibility for establishing mortgage rate policy in the United States. In addition, this individual should be held responsible for assuring that good, solid credit standards are followed in every loan that is put into a security backed by the Federal system.

For those people concerned about the Government’s continued involvement in the housing sector of our country, I would say that mortgage debt is too important to leave in the total control of the independent banks. History has shown, whether we look back on the S&L period or this most recent period, that private needs do not always fit well with public needs.

It has been a well-kept secret, but any reasonable analysis will show that the Government run programs and the loan portfolios of Ginnie Mae, the FHA, and the VA significantly outperformed those managed by the “independent banks” and Fannie Mae and Freddie Mac.

Home loan risk is not rocket science and it should not be treated as such. Any first year student taking finance 101, economics 101, or accounting 101 could have managed the housing risk these last twenty plus years better than the executives at the independent banks and the GSEs. It may be sad that we have to take the actions that I am recommending; however, we are left with few other choices considering the size and importance of mortgage debt to our economy.

My solution will work and it will not result in a “third” housing crisis in the United States. I am only hoping that the Treasury Secretary’s conference comes to a similar conclusion. If not, then I am afraid that twenty years hence, another group of inexperienced leaders will have to deal with a problem that their predecessors could have and should have resolved when they had the chance.

Jim Boswell has an M.B.A. degree from The Wharton School (University of Pennsylvania), an M.P.A. from School of Public and Environmental Affairs (Indiana University), and a B.A. degree from Hanover College. His recently published book, Crush Depth Alert, Fourth Lloyd Productions, explains in detail with supporting exhibits, graphs, and tables the factors that led up to the recent financial crisis while offering solutions on how to move forward. This is a follow-up to an earlier BusinessInsider.com article (June 24, 2010) by Boswell called “How 25 Years of Mismanagement at Fannie and Freddie Caused The Financial Crisis”.

You can purchase Crush Depth Alert here.

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