I’ve repeatedly said since 2009 that the further in time we get from the crisis, the greater the probability that Fannie Mae and Freddie Mac would survive in some form.  Such looks like an ever-increasing likelihood.  I’m occasionally asked if there are any reforms that would make Fannie & Freddie acceptable.  I’m tempted to say “no.”

In the spirit of lively debate, I submit the following changes to address most of the flaws in the government sponsored enterprise (GSE) model that would also allow the companies to survive in some form.  I do emphasize that this is not an argument for keeping the GSEs.  That’s a different question altogether.

1)   Open up the charters to competition.  If we learned anything from the rampant corruption that characterized early 1800s U.S. state banking, it is that legislators shouldn’t give out exclusive charters.  Accordingly, the government should delegate chartering authority to the regulator and allow anyone who can meet the requirements to get a charter.

2)   Increase Capital.  Fannie and Freddie were (and still are) massively leveraged.  Laurie Goodman suggests 4 to 5 percent would be a reasonable minimum capital.  I believe something closer to what insurance companies have–around 8 percent (real, not risk-weighted) would be appropriate.  While I’m not completely in the Admati camp on capital, I do agree with her general point that capital isn’t “dead” –it would be used for lending.  And since GSEs aren’t providing some form of payment medium like banks, I see little cost to requiring higher capital levels. So I’d say 8 percent, if not more.

3)   Ditch loan limits, go with income.  In order to make sure these entities actually serve middle-class America, rather than be a subsidy to the well-off, we should eliminate the loan limits and make mortgage eligibility based on income.  This is similar to the USDA’s Rural Housing Service loans.

4)   Break ‘em up.  This might be the most controversial, but simply allowing other institutions to enter the market is unlikely to guarantee sufficient competition.  We broke up Ma Bell.  Under any antitrust standard, Fannie and Freddie are a duopoly.  Unless we are repealing the Sherman Act, the two companies should be broken into at least 6 pieces each and barred from merging.  Existing shareholders would get shares in the off-spring companies.

5)   Require More Mortgage Insurance.  In order to protect the taxpayer, mortgage insurance companies should take the first 35 percent of loss, instead of the customary 20 percent.

6)   Improve Underwriting Standards.  End the housing goals and require minimum down payments of 5 percent and minimum FICO scores of 700.

7)   End all securities law exemptions.  Subject companies to 1933 & 1934 Act requirements.

8)   End banking law preferences.  Banks aren’t allowed to hold corporate equity, except for that of GSEs.  We know how that turned out.  For the purposes of all banking regulation, especially capital and asset concentration limits, treat GSE securities as you would any other corporate security.

9)   Limit portfolios.  Allow portfolios to be used for an inventory function only. A minimum of 90 percent of debt issued should be required to be mortgage-backed securities (MBS).

These are just some initial thoughts.  Implementing all of these would go a long way towards bringing competition to our mortgage markets and protecting the taxpayer.  If some remain concerned that this lacks a “catastrophic” backstop, then we can allow the Federal Home Loan Banks to discount advances on the MBS issued by these new and improved GSEs.