The Mortgage Finance Act of 2011, Counterproductive to Housing Reform

Mortgage Finance Act of 2011 – legislation submitted by Sen. Johnny Isakson with little chance of passing congressional scrutiny; the act is, unfortunately, an example of political showmanship, appealing to public opinion on a critical policy issue. Furthermore, the Act clutters the congressional to-do list, regarding housing reform.

Make waves and the voters will take notice?

Don’t be so sure this time, Senator – the public is surprisingly well read on the matter, and offering no plan to build a fantasy world, characterized by a “completely privatized secondary mortgage market” bodes poorly on the proposal. Senator Isakson can’t seriously mean to implode the very institution that made his realty career possible. Additionally, this new secondary market will be subject to the regulations of the Dodd-Frank legislation. Yes, that is correct – Isakson proposes to encourage private business to enter a secondary mortgage market, just after adding new restrictions on the market, making profit more difficult to come by (limited short-term profit opportunity). The private sector became an active participant in subprime mortgages only after the SEC and HUD loosened regulations in 2004, apparently to drive the subprime mortgage market.

Isakson’s next mistake: the private mortgage industry,  once muddied with investment banking, was at the root of the previous financial collapse, forcing out Fannie Mae’s careful approach to the subprime market. First, the Securities and Exchange Commission relaxed its rules on investment bank borrowing, allowing  Lehman Bros, Bear Stearns, and Merrill Lynch to over-leverage, borrowing cash to compete in the secondary mortgage market. Subprime opportunity was ripe, as the Federal Reserve had slashed interest rates. These investment banks lured in borrowers with seemingly low-cost financing, approving low-rate mortgages without concern for borrower credit worthiness. However, these mortgages were designed off floating rate platforms, with a number of additional quirks, bringing inevitable doom to borrowers, as interest rates were sure to climb. The banks appeared to limit the risk of borrower default by purchasing (CDSs) Credit Default Swaps (mortgage “insurance”) from the likes of A.I.G. As a result, the mortgages could be repackaged and sold as Mortgage Backed Securities to investors who focused on the future returns of floating rates, without the typical subprime risk of default (made possible by the credit default swaps).

The investment banks were selling fools gold, bringing inevitable doom to borrowers, blinded by the lure of home “ownership,” and investors who ignorantly found comfort in the pseudo insurance provided by the CDSwaps. This reckless behavior successfully stripped away Fannie Mae’s oversight of the subprime market, as the mortgage giant was unable to compete with Investment Banking gimmicks; Fannie was forced to abandon its subprime conservatism, in an effort to reacquire market share. Clearly, Mr. Isakson has forgotten which sector brought on the business of risky lending. Maybe because the three investment banks mentioned all when bankrupt, and nobody can point fingers at ghosts.

Yet another mistake: Isakson has not considered the amount resources necessary, to repurchase mortgages in mass, repackage them along appropriate risk profiles, and sell the mortgage backed securities. It took over $4trillion in debt just to bring investment banks into the subprime picture. Is the hope that all these “private businesses” (whatever that means) will come together, willingly combine mortgage notes with one another and seamlessly work together to market the resulting securities? Not likely. Companies must carry billions of dollars to even consider maintaining meaningful portfolio. No business could now put forth enough cash to acquire a large enough portfolio of mortgages to diversify risk and maximize projected return well enough to produce marketable Mortgage Backed Securities. Furthermore, the personnel and systems necessary to streamline the process would take years to establish (not to mention the marketing required to sell off these securities in a competitive environment).

Is there a company out there with access to enough cash, personnel, and resources to even consider moving forward on such an ENORMOUS undertaking?

I can think of two.

Fannie Mae and Freddie Mac… Sure, there are some mega companies out there who, theoretically, could make business out of the secondary mortgage market, but it would take a huge re-allocation of resources, and the opportunity cost is too high in this day of economic reconstruction. The futility of “private” enterprise entering the marketplace is evidence by the catastrophic results of the five largest investment banks (who entered the market in 2004), three of which disappeared.

It would take generations to build a secondary mortgage market out of thin air, at least to the scale the American public requires. So what do legislative proposals do for progress, other than needlessly occupy congress’ attention. In terms of reform and progress, this bill is, graciously put, counterproductive. It is a shame that our elected officials would place politics over government, using proposed legislation to collect votes from an angry, finger-pointing constituency.

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Tony Salloum

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By Tony Salloum