This paper assumes the government-sponsored enterprises (GSEs, specifically Fannie Mae and Freddie Mac) are unsustainable; the expected costs they create for U.S. taxpayers far exceed their expected benefits. The question addressed is, then, how to reorganize the U.S. mortgage market in the absence of GSEs. This paper focuses on a specific mortgage-market reform proposal to abolish the GSEs and substitute private market incentives for mortgage originators, securitizers, and investors while retaining the Federal Housing Administration and U.S. Department of Housing and Urban Development programs that support lower-income and first-time homebuyers. This paper assembles data showing that stable housing and mortgage activity can be sustained with minimal government intervention, including data that demonstrate the success of western European housing and mortgage markets that operate with little government intervention. This paper offers two alternatives for reforming the government-sponsored enterprises (GSEs) Freddie Mac and Fannie Mae. The first approach is to restore the status quo ante, meaning that Freddie Mac and Fannie Mae would be returned to the investing public as private corporations with government backing, able to purchase loans for securities and hold securities in their portfolio, subject to safety-and-soundness regulation and limits on loan amounts. This “devil-you-know” strategy would be safer than trying to create a new government-guaranteed mortgage system. The second approach would be for the government to get out of the mortgage guarantee business and let the mortgage market evolve in a decentralized way.

This “Jimmy Stewart banker” strategy would return mortgage lending to local banks, which would retain the loans they originate. The United States government has had a large role in supporting housing for at least 80 years, but it is clear that the costs of these government policies far outweigh the benefits. The United States does not rank especially high in homeownership among developed countries, and the interest rates that Americans pay for their mortgages are also higher than the rates in other developed countries. In addition, and most importantly, the taxpayers have been called upon for hundreds of billions of dollars to bail out various government-sponsored housing-finance programs that have suffered major losses over this period. The solution is to eliminate the government’s role in housing, except for a limited and carefully structured program that will allow low-income borrowers to become homeowners. In general, however, legislation—by defining a prime mortgage—should ensure that the preponderance of all mortgages are prime quality and that only prime mortgages are securitized. Once this process is established, the government sponsored enterprises Fannie Mae and Freddie Mac can be gradually withdrawn from the market by reducing their conforming loan limits over a five-year period. As Fannie and Freddie leave the market, private-sector securitizes will establish a robust and competitive market in securitizing prime mortgages.