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Government needs to enforce transparency in housing securitization

In discussions of what to do about Fannie Mae and Freddie Mac, some people are recommending that government get out of housing finance entirely. That would be a mistake, say economists Adam Levintin and Susan Wachter writing in The New York Times March 8,  because securitization, to revive, needs to be transparent to investors, and private markets will never voluntarily be transparent.

From the article:

As we examined in a study, the housing bubble and financial crisis stemmed from the private market’s oversupply of risky mortgage products through private securitization. Critical to ensuring the revitalization of the housing finance system is ensuring transparency of credit risk to investors. Government guarantees are one way of doing so, although not the only one. What is necessary is standardization of products and securitization to ensure information flows that will allow investors to accurately price risk.

Government should have a hand in this, because taxpayers will always have to bail out housing, argue Levitin of Georgetown University and Wachter of the University of Pennsylvania.

From the article:

The risk of the housing finance market is inevitably socialized — unlike other markets, the government will always step in to prevent a collapse of the housing finance market.

Given that housing risk is socialized, it is important that we ensure that the financing products are the ones that reduce, rather than create, risk. A complete privatization of housing finance would create systemic risk and therefore encourage bailouts, not prevent them. At minimum, we need the government to promote standardization and transparency of mortgage products and financing to prevent the underpricing of mortgage risk that produced the housing crisis.

A large part of housing finance in recent decades was securitization, where trusts pool mortgages and sell  mortgage-backed securities backed by those pools.  Financial institutions often used these securities as collateral for repo loans. The credit crisis in 2007 and 2008 occurred when repo lenders panicked about the quality of those securities and stopped lending. Today repo lenders will not finance housing unless the collateral is government guaranteed.

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One response to “Government needs to enforce transparency in housing securitization

  1. The phasing out of Fannie Mae and Freddie Mac will bring back private capital and banks to the real estate market and the playing field will be level for private capital investment. Borrowers will also be required to put down a larger down payment.

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