Last week a group of eight U.S. Senators sent a letter to Federal Housing Finance Agency (FHFA) Director Mel Watt regarding concerns over what’s known as the Common Securitization Platform.
This “platform” is meant to standardize the process of issuing mortgage-backed securities (MBS) in the U.S., and the FHFA has been working on it for more than two years.
The FHFA is promoting the “platform” as nothing more than a way to make it easier to buy and sell MBS, even if Congress decides to shut down Fannie and Freddie. Fannie and Freddie supported a large volume of home loan securitization, and the standardized platform would supposedly do the same.
The idea even made it into one of the proposed housing finance reform bills in the previous Congress. That bill would have eliminated Fannie and Freddie and replaced them with this very same platform under the name National Mortgage Market Utility.
But forcing this platform on the market in this manner amounts to telling Americans they can have any kind of housing finance system they want, as long as they choose this one.
It would largely preserve the system that imploded in 2008 – the one that encourages banks to originate loans and sell them into the secondary market. There is nothing wrong with this practice, per se, but government policy should not bias the market toward it.
This new version is supposed to be better, though, because the platform is a separate entity which – unlike Fannie and Freddie – only issues MBS and doesn’t actually own a portfolio of MBS.
Besides, it’s a public utility, a highly regulated company that couldn’t possibly cost taxpayers money or lead to a major financial crisis. Right?
Congress should ignore this view and rip the platform out by its roots while it still can. Otherwise, instead of Fannie and Freddie issuing virtually all the MBS in the market, the platform will.
Ultimately, the platform will further socialize the cost of financial risk-taking, restrict competition, concentrate financial risk, raise consumer prices, and do virtually nothing to reduce the likelihood of future bailouts.
Defenders will say there’s no reason to fear a bailout because the platform won’t actually own any MBS. But the platform – if it replaces Fannie and Freddie – would certainly be what Dodd-Frank calls a systemically important financial market utility (FMU).
In layman’s terms, a systemically important FMU is a special type of financial company that federal regulators deem too big to fail. Formally, Title VIII of Dodd-Frank defines an FMU as:
“any person that manages or operates a multilateral system for the purpose of transferring, clearing, or settling payments, securities, or other financial transactions among financial institutions or between financial institutions and the person.”
[See this paper for more detail on payment, clearing, and settlement (PCS) firms, as well as Title VIII and the FMU concept.]
Under Dodd-Frank, PCS companies that qualify for an FMU designation implicitly qualify as public utilities. The fact that the new securitization platform will be regarded as a systemically important FMU is bad enough, but the fact that policymakers are conflating financial companies with public utilities is even worse.
It’s particularly dangerous because the term public utility is not an objective economic concept. The term is political and lends itself to broad applications by those who want to extensively regulate and even nationalize private companies.
It’s fundamentally equivalent to using the general welfare clause of the Constitution to argue that the federal government should dictate how many firms can operate in an industry and how much profit they can earn.
In the more extreme case of nationalization, it’s the same as arguing our nation’s founders included the general welfare clause because they believed in socialism rather than free enterprise and economic freedom.
It may seem like I’m taking this argument too far, but there are many recent examples of left-leaning pundits actually calling for socialization, nationalization, or public utility status for new classes of private firms.
For instance, Michael Lind, co-founder of the New America Foundation, recently argued that basic transactional banking is a public utility. He defended his position by pointing out that Alexander Hamilton, first U.S. Treasury Secretary, also referred to banking as a public utility.
But Hamilton’s sense of the term public utility was nothing like the term—or banking, for that matter—as it is currently known. In the 1700s many of the nation’s founders used the term public utility to emphasize that activities and institutions, ranging from government itself to the distribution of bibles, would be good for the public.
Broad applications of the term public utility were always a source of conflict among the nation’s founders. Those who favored a weaker central government preferred a narrower view, while others viewed a much wider range of government activities as fostering the public utility.
The term is very similar to the English common law doctrine known as the public interest. In fact, the modern U.S. regulatory framework for public utilities has its roots in this very concept.
Munn v. Illinois, an 1876 Supreme Court case, invoked the public interest to affirm the right of state governments to regulate prices charged by certain private companies.
This brings us to inquire as to the principles upon which this power of regulation rests. . . . Looking, then, to the common law, from whence came the right which the Constitution protects, we find that when private property is “affected with a public interest, it ceases to be juris privati only.” This was said by Lord Chief Justice Hale more than two hundred years ago, in his treatise De Portibus Maris, i Harg. Law Tracts, 78, and has been accepted without objection as an essential element in the law of property ever since.
The truth, though, is that this principle has never been “accepted without objection.”
Munn v. Illinois was itself a controversial decision, and “its 200 year old legal reasoning was widely debated among legal scholars for the next half century after its adoption.”
Furthermore Lord Hale’s 17th century treatise justifies price regulation of a government-licensed business, such as a port, which all customers must use. In such a case, Hale reasoned, special rules were needed to ensure that companies would charge “reasonable tolls” rather than whatever (presumably higher) price the market would bear.
Thus, the text provides the reasoning for regulating a monopoly after it was created by the state, but it certainly does not justify creating a regulated monopoly. (And at least one historian has argued that Waite completely transformed the meaning of the term public interest.)
For hundreds of years, those who favor free enterprise and a weaker central government have argued against the public utility concept. When it comes to financial markets, they’re rapidly losing ground to those who prefer government regulation and provision of services.
- Norbert J. Michel is a research fellow specializing in financial regulation for The Heritage Foundation’s Thomas A. Roe Institute for Economic Policy Studies.
Originally appeared in Forbes
