Paul Volcker Says Mortgage Market Will 'Have To Be Reconstructed' (VIDEO)

Paul Volcker Says Mortgage Market Will 'Have To Be Reconstructed' (VIDEO)

Former Federal Reserve Chairman Paul Volcker said the nation's home mortgage market is in trouble and will have to be "reconstructed."

"It's totally dependent, heavily dependent on government participation," Volcker said Friday in an interview with Bloomberg Television. "It shouldn't be that way. That's going to have to be reconstructed."

The federal government was responsible for up to 95 percent of all new home mortgages in the fourth quarter of 2009, said Guy Cecala, publisher of Inside Mortgage Finance, a leading industry publication.

"Anyone who looks at the numbers says, 'My God, look what it's come to,'" Cecala said in an interview Friday.

While Volcker hopes the nation's home mortgage finance system lessens its dependence on taxpayers, Cecala said it's going to be nearly impossible for a significant change to take place over the next year.

"We can't," Cecala said. "It certainly can't change in 2010. It's like saying we're going to make some improvements in the Titanic after it's hit the iceberg."

There were $390 billion in new mortgage originations, including home equity lines, in the last quarter of 2009, according to Cecala's firm. Excluding the home equity lines, Fannie Mae, Freddie Mac, the Federal Housing Administration and the Veterans Administration stood behind up to 95 percent of those mortgages. Just a few years ago the government was responsible for about 40 percent of all new home mortgages, Cecala said.

By buying up mortgages from lenders, Fannie and Freddie control about $5.5 trillion in home mortgages, according to their federal regulator. That's nearly half of all outstanding mortgage debt in this country. Their share of the mortgage market is nearly double what it was 20 years ago. They were effectively nationalized in September 2008.

Cecala noted that in 2005, the amount of private mortgage-backed securities exceeded the total output of Fannie, Freddie, FHA and the VA combined. That year there was about $613 billion in private bonds that contained creditworthy mortgages (excluding subprime). In 2009, there was just $5.5 billion.

Attracting lenders and investors back into mortgage finance, without the promise of a government guarantee, will be key to lessening the federal government's involvement. That means getting Fannie Mae and Freddie Mac to dial back their taxpayer-subsidized purchases and guarantees of mortgages.

"Fannie Mae and Freddie Mac were not a good idea in the first place," Volcker said. "This hybrid public, private thing sooner or later was going to get you in trouble -- and it sure got us in trouble big time," he said. "I hope we don't go back to that model."

Cecala said that unless the private securitization market returns, it'll be hard for the federal government to dial back its involvement. While analysts expect an uptick in private mortgage securitizations this year, Cecala said it won't be enough.

The government "needs to provide a way to support, and I don't know how they're going to do it without some sort of government guarantee," Cecala said. One approach could be for the government to guarantee mortgages held and securitized by banks, and then slowly decrease the level of that guarantee until confidence fully returns.

Last month, House Financial Services Committee Chairman Barney Frank (D-Mass.) vowed to get rid of mortgage giants Fannie Mae and Freddie Mac as part of an overhaul of the country's taxpayer-supported system for financing home loans.

"The remedy here is to, in fact, as I believe this committee will be recommending, abolishing Fannie Mae and Freddie Mac in their current form and coming up with a whole new system of housing finance," Frank said. "That's the approach, rather than a piecemeal one."

The Obama administration expects to outline its future plans for Fannie and Freddie later this year.

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