The Agenda

Chris Papagianis on the Way Forward for GSE Reform

My Economics 21 colleague Chris Papagianis testified before the Subcommittee on Capital Markets and Government Sponsored Enterprises this morning, and his remarks are available at the site. He offers a strategy for reducing the risks the GSEs pose to taxpayers:


Before commenting on the individual proposals, I want to describe briefly what I think is the key analytical challenge before this committee – namely, that the most egregious excesses of the previous GSE model are not necessarily the primary sources of taxpayer losses (so far). The key take-away from this, I believe, is that there is still a lot of taxpayer risk in the GSE system. This means that near-term reform proposals can have important benefits even if they do not get at the root cause of most of the GSE losses over the past few years.

For example, the first instinct of many reformers would be to ensure that the GSEs (or their successors) are never again allowed to amass big mortgage portfolios. The second instinct would probably be to strictly limit the mortgages that would qualify for purchase (or guarantee) by the GSEs.

Both of these reforms make sense – and should be pursued today. At the same time, addressing just these two issues now would not “fix” the problem with the GSEs or make the GSE model sustainable in the long-term. Of the GSEs’ combined $226 billion in losses, over $166 billion (73%) are from the guarantee business. The investment portfolio accounts for just $21 billion (9%) of the losses. Had the investment portfolios been eliminated, in say 2005 as proposed by some in Congress, the GSEs would have still suffered losses from guaranteed mortgages that would have wiped out their capital base several times over.

More specifically, Chris calls for putting the GSEs into receivership and liquidating them over a period of several years:

The likely result would be higher mortgage costs generally, as the old (mispriced) government guarantees would be paid for by mortgage borrowers (upfront) instead of by taxpayers (over the long-term). But, as the Treasury department commented in theirrecent white paper: “mortgage rates are likely to rise somewhat under any responsible reform proposal.” If Congress wants to offset some of this cost increase, it has options – it could explore ways to explicitly subsidize low-income borrowers through on-budget housing programs or through mechanisms like interest rate swaps.

In the near term, he offers a number of other practical suggestions. 

Reihan Salam is executive editor of National Review and a National Review Institute policy fellow.

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