Excerpt of a new mortgage-industry idea seen at Bloomberg.com:
We can’t rely on the same private mortgage system, which specialized in the production and sale of fraudulent securities and almost vaporized the global financial market. The Dodd-Frank law notwithstanding, credit-rating companies are still on the take, regulators are still on the make, and boards of directors are still on a break. They won’t protect us from Wall Street’s sale of snake oil.
We need a new limited-purpose mortgage system, which confines banks and other mortgage makers to doing just one thing — connecting lenders with borrowers, not leveraging the taxpayer. And we need the government to directly oversee the mortgage initiation process, organize a competitive market in home loans, and fully disclose all the details of mortgages on the Web so investors in these loans will know what they are buying.
This is remarkably easy to accomplish.
Step 1: Set up a new government agency — the Federal Financial Authority. The FFA would hire companies to verify, rate, appraise and disclose mortgage applications. These contractors would work exclusively for the FFA, eliminating any conflict of interest. Liar loans and no-doc loans would be history.
Mutual Funds’ Role
The government would neither endorse nor accept responsibility for appraisals and ratings, and would let borrowers add privately purchased appraisals and ratings to disclosures.
Step 2: Limit buyers of home loans to doing so only through closed-end mortgage mutual funds. If a fund manager chooses poor mortgages, the value of his fund’s shares will fall, but the fund itself won’t go broke. Mortgage defaults will never again lead to financial-sector collapse.
The mutual funds would sell shares up to a closing date, use the proceeds to buy mortgages of the type in which they are specializing, and pay out the cash flow to stockholders. The funds would terminate when the loans mature.
Step 3: Establish an electronic mortgage auction and require mutual funds to purchase loans at this market so borrowers receive the best price (lowest interest rate).
While mutual funds would buy and hold mortgages, their shares would sell in a secondary market so investors would have liquidity even though their funds’ assets were illiquid. For this secondary market to operate well, it would need to maintain real-time disclosure of all information relevant to the valuation of a given loan.
The mutual funds would, themselves, represent securitizations. But unlike yesterday’s complex mortgage securities, investors would know what they were buying.
Investors seeking safety would purchase funds specializing in loans with larger down payments and shorter maturities. Investors seeking higher returns at the price of more risk would buy funds focused on mortgages with low down payments and longer maturities.
It’s time for the government to move from making home loans to making a mortgage market that works. The limited purpose mortgage system does both.
Laurence Kotlikoff is professor of economics at Boston University, president of Economic Security Planning Inc. and author of Jimmy Stewart Is Dead.” Richard Field is managing director of TYI LLC, a disclosure compliance database and risk- management firm. The opinions expressed their own.