Mistimed Housing Finance Reform Could Derail Housing Recovery

Over the last couple of years Christopher Whalen of Institutional Risk Analytics has proven to be one of the best financial analysts out there, especially when it comes to banking matters.   There is a really interesting article on his website this morning “Conflict of Visions: Housing Market Reform and Recovery” that is well worth reading, especially if you happen to be a lawmaker in Washington (which of course you aren’t).

If you haven’t been paying any attention, reform of the housing finance system is a hot topic in Washington lately.  What role the government should take in housing finance is the biggest issue.  There is sharply divergent opinion over how much of the blame for the housing bubble is borne by Fannie Mae, Freddie Mac, the FHA, et. al.

The Obama Administration is set to release a report in the coming weeks recommending a course of action with regard to the future of housing finance.  It is rumored that the administration will call for a 50% reduction in the government’s share of the mortgage market over the next five years.  The government currently backs or insures 99% of all residential mortgage originations.

Some, such as Rep Scott Garrett (R-NJ) have stated their desire to totally privatize the mortgage market:

“Let me stress and be very clear where I stand: I am firmly committed to a purely private U.S. mortgage market over time, free of any government subsidies or guarantees.”

Sen. Rand Paul (R-KY) recently proposed a budget that would totally defund the Department of Housing and Urban Development, which includes the FHA, which is a crucial source of financing right now.

Within the Whalen article, he references another article by Dan Alpert of Westwood Capital, in which Westwood states that he sees a 5-8% decline in home values over the next year, and a recovery in the housing market starting in 2012.  Alpert that by this time, much of the unsold housing inventory will be absorbed, and it will have a diminishing impact on home values.  Whalen seems to agree with this view, but says that proposed government reforms could derail the recovery:

“If you can imagine the guarantee fees for the GSEs doubling as apparently proposed under the Geithner and various GOP reform plans, this implies a shrinkage in the available supply of home credit that is truly horrendous. And you can kiss that 2012 housing market recovery goodbye as well.”

It is pretty clear to me that for better or worse, government support is what is keeping the housing market going right now.  It is also clear to me that there is a huge need for reform in the mortgage marketplace.  However, I don’t think that now is the time to implement reforms that would drastically reduce the availability of credit and potentially hurt the market.  Before removing government support, we need to be 100% sure that the private market is there to pick up the slack.  I am not sure that is the case at the present time.