Policymakers are talking about replacing Fannie Mae and Freddie Mac, but creating a new government guarantor of mortgages just means there’ll be another bailout down the road. Arnold Kling explains how the rent-seeking game created the subprime crisis and how that game will likely continue in a post-Freddie/Fannie world:
As usual, Wall Street needed favorable regulatory rulings in order to get its subprime machine rolling. What was most important was that bank regulators tilted capital regulations in favor of highly-rated securities. As a result, the capital requirements for a bank holding a very safe mortgage where the borrower had made a down payment of 30 percent were more onerous than those for a bank holding a CDO tranche backed by the most dodgy subprime loans with low down payments, as long as the issuer of the security could find a rating agency willing to confer its AAA blessing on that tranche. The tilt away from originate-to-hold and toward originate-to-distribute was a matter of what even public officials termed “regulatory capital arbitrage.”
For Wall Street, the ideal situation is one in which taxpayers provide a guarantee that makes mortgage securities viable, banks remain hamstrung by capital requirements that penalize them for holding loans that they originate, and the government enterprise that supplies the guarantee is not permitted to have a portfolio of securities, the way Freddie Mac and Fannie Mae have operated.
Today, the housing finance reforms that have the most bipartisan support appear to do exactly what Wall Street wants. They create a new government agency to guarantee mortgage securities. They do nothing about the perverse capital requirements that penalize banks that originate safe loans while rewarding banks that hold securities backed by dodgy loans. They ensure that mortgage securitization, which has never demonstrated an ability to compete on a level playing field in the market, will continue to dominate the American mortgage market. Whenever this system suffers its next crisis, taxpayers will be delivering the bailout. The mortgage bankers and Wall Street firms win. You lose. [The American, August 21]