Figure Out Government's Role in Housing, Bernanke Tells Lawmakers

NEW YORK ( TheStreet) -- Policymakers should first decide on the government's role in housing as they attempt to shape the future of housing finance, Federal Reserve Chairman Ben Bernanke told members of the House Financial Services Committee on Wednesday.

In the Q&A session following his prepared remarks, Bernanke fielded many questions on the role of the government-sponsored enterprises (GSEs), Fannie Mae ( FNMA) and Freddie Mac ( FMCC), the relevance of a 30-year fixed rate mortgage and whether the private market could function well in times of crisis without a government backstop.

Bernanke told lawmakers that he believed the old GSE model "had very serious flaws." It had an implicit government guarantee that was not paid for, there was a serious lack of capital and the agencies were "torn between public and private purposes."

He also said that he did not believe the government guarantee had been effective in lowering mortgage rates for homebuyers and also noted that other countries had normally functioning housing markets, despite the lack of guaranteed, 30-year fixed-rate mortgage loans.

Still, Bernanke did not appear to advocate any single reform plan. "There are a number of plans out there. One of the key questions is what role, if any, government should play. It seems pretty clear that private capital should have a greater role," he told lawmakers, with the government right now backing nine out of 10 newly originated mortgages.

If lawmakers decide the government guarantee should continue, taxpayers should be adequately compensated for the risk. As the Federal Deposit Insurance Corporation does to guarantee deposits in the event of a bank failure, the government should collect some sort of insurance premium to guarantee payments to investors who purchase mortgage-backed securities.

"Either you have to be 100% confident in the private thing you set up, or if you think there is a scenario where the government will be exposed, the government needs to be paid ex-ante," he said.

The House Financial Services Committee is scheduled to have a hearing on Chairman Jeb Hensarling's recently-introduced "Protecting American Taxpayers and Homeowners" proposal on Thursday.

Hensarling's PATH proposal aims at dissolving the bailed-out housing giants in five years, after which private capital will step in to fill the void, with no government guarantee.

This is different from other GSE reform proposals, notably the bipartisan Corker-Warner bill, that also sees an end to the old GSE model, but still advocates a government backstop.

Still others, mainly professional investors who have been betting on Fannie and Freddie junior preferred shares, are arguing that the agencies be allowed to live, but with more capital and more regulation.

On the subject of the housing recovery, Bernanke said that the Fed would closely monitor the impact of rising mortgage rates on housing demand.

In his prepared remarks, Bernanke noted the strong progress in housing and its positive impact on construction activity and household wealth and said the housing recovery should continue notwithstanding the rise in interest rates.

--Written by Shanthi Bharatwaj in New York.

Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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