The Federal Reserve Bank of New York published a paper this week suggesting a new model for the secondary market where lenders would hold a stake in securitization, known as a lender-cooperative utility that could replace Fannie Mae and Freddie Mac. Under the model, a membership of financial institutions would mutually own a cooperative that would carry out the securitization of mortgage loans. Because those members would be the owner’s of the cooperative, any profits or losses that come from the effort would be returned on a pro-rata basis. This means that the more the financial institutions put in, the more they get back or lose. US Department of Housing and Urban Development (HUD) secretary Shaun Donovan said recently that the government is currently working on a plan for the government-sponsored enterprises (GSEs) by the end of the year. The NY Fed suggestion for their replacement, this lender-cooperative utility, should include a broad range of financial institutions, both large and small lenders, as well as banks and nonbanks. Key decision-making would be granted to a board of directors made up of both members and independents but mostly the former. Because the bulk of mortgage originations in the country is highly concentrated, the cooperative must ensure smaller companies have equal access to it. Currently, more than 60% of US origination is done by the big-four banks: Wells Fargo, Bank of America, JPMorgan Chase, and Citigroup, according to the NY Fed paper. The new model would theoretically lower the costs of securitization and limit the ability of one member to form a monopoly, as has been suggested Fannie and Freddie did. The thinking is that the proportional returns on the securities would merely influence competition in the primary market to originate more mortgages. An important caveat, the authors add, is that this argument assumes the originators do not collude. The authors also note some potential setbacks to such a cooperative. Governance of such a membership could be weak and lack market discipline. Broad participation might be hard to come by, and investment and innovation would be limited. “While cooperative structures face significant challenges, particularly in their governance, we believe these problems are tractable and outweighed by the advantages a cooperative has in addressing some of the central incentive problems evident in Fannie Mae and Freddie Mac,” according to the report. Write to Jon Prior.

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