The Benefits of Multiple Guarantors

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Earlier this year, MBA released a white paper on how best to reform the secondary mortgage market and create a stable and durable foundation for housing finance and the thirty year fixed rate mortgage that is so integral to the American dream of homeownership.

One of the main points we emphasized is the need to allow multiple (two or more) guarantors in any future system. This arrangement would, of course, potentially end the current duopoly of Fannie Mae and Freddie Mac, creating much greater competition. Given the deep history of these two entities, and their involvement in the housing industry, there are some who question the benefits of a multiple guarantor model, and suggest we preserve the current duopoly.

So, allow me to explain our thinking.

First, markets and consumers are always best served by competitive forces.  Multiple guarantors would give all lenders – but especially smaller lenders – more options. No lender would be required to work with a specific guarantor or to work with all guarantors.  Instead, lenders would able to work with the guarantor or guarantors of their choice.  In the MBA model, existing relationships with a re-chartered Fannie Mae or Freddie Mac would be retained.  However, if new guarantors enter the market and begin to compete for business on the basis of product focus, service levels, or the desire to work with smaller lenders, the choice to switch to a new guarantor becomes a simple cost-benefit assessment for each lender.  Who has the best products for my markets?  Whose systems and technology are the easiest to work with?  Who has account reps that understand my company and my business model?

Additional entrants, or the threat of them, would encourage innovation and spur the guarantors to provide better service to their seller/servicers and ultimately to consumers. Additionally, the prospect of new guarantors would ensure that the existing ones have an incentive to compete against each other in areas such as: offering technology solutions and systems for interfacing with seller/servicers; structuring and executing risk-sharing transactions; product innovation; pricing and execution; and customer service.  This sort of competition – even the prospect of such competition – will make Fannie Mae and Freddie better at what they do and prevent the market from stagnating.  This is why MBA’s model would allow the regulator to charter new entrants, and takes steps to lower barriers to entry through the uniform/single security and common securitization platform.

Some have argued that adding new guarantors would increase risk by creating more “too big to fail” entities.  Nothing could be further from the truth.  In fact, one of primary benefits of a multiple guarantor model for the secondary mortgage market would be reducing the taxpayer’s exposure by diversifying risk across multiples entities.  Spreading operational risk, credit risk, market risk, and model risk across three entities (or four) instead of just two by definition reduces overall risk to the system.  By ending the Fannie/Freddie duopoly and adding guarantors, the inherent risk would be spread among more entities, lessening the chance that a widespread economic disruption would cause the failure of all guarantors and require another bailout.

The bottom line is that more guarantors equals more choice for lenders, better options for borrowers and less risk for taxpayers. MBA’s plan for GSE reform would ensure a stable foundation for the secondary mortgage market, reducing the risk of another taxpayer bailout. After all, GSE reform is the last piece of unfinished business from the financial meltdown. It’s time to get this over the finish line and ensure the stability of the secondary mortgage market and the thirty year fixed rate mortgage in order to protect consumers and reduce the burden on hard working taxpayers.