Financial reform without dealing with Fannie Mae (FNM) and Freddie Mac (FRE) is like establishing rules for kids without addressing the sins of the parents. Had it not been for these two housing GSEs, there would have been no financial crisis in the United States in 2008, there would have been no need for TARP funding and bank bailouts, and although we might still be facing a debt crisis in America for non-housing matters, our debt situation would be much more manageable than it is today.

There are several things that Congress should have learned from the current financial crisis, but which they seem to ignore in the current financial reform bill. One, mortgage debt has become one of the most important factors affecting our economy that we need to control. Two, millions of dollars can be made in the business of mortgage-backed securities without paying out million dollar salaries. And three, Fannie Mae and Freddie Mac controlled their own money-making machines and neither of the two GSEs could be trusted to do what was best for the general welfare of the people of the United States.

Strong words, but it is the truth.

While considering financial reform today, no one should ignore the fact that Fannie Mae and Freddie Mac set mortgage rate policy and the underwriting standards for housing in America. And as a result of their self-serving policies, the GSEs must be held primarily responsible for the inappropriate growth in mortgage debt that led to our most recent financial crisis.

During the fifteen year period between 1992 and 2007 American homeowners increased the total amount of their housing debt from $2.8 Trillion to $10.2 Trillion, almost a three-fold increase of $7.4 Trillion. This increase in housing debt was greater than the increase of the better known National Debt, which went from $4.1 Trillion to $9.0 Trillion during the same time period.

Talk about deficit spending. As we refinanced and refinanced our homes we mortgaged our future so that we could keep our consumer-based economy rolling along. While we did this, the people in charge of watching and running our economy stood by idly while receiving constant accolades for their performance.

No wonder Alan Greenspan was considered an economic genius. During his reign of good times, we were stimulating our economy with such a large amount of unjustifiable debt that any Keynesian economist of the 1930’s would be envious.

The million (or should we say trillion) dollar question today is this. Why has Congress ignored doing anything about the actual organizations (the GSEs) responsible for the recent financial crisis in their upcoming financial reform bill?

There are several fundamental reasons. One, the people who are responsible for designing the new financial legislation know nothing about mortgage-backed securities and the games that the GSEs played over the last twenty-five years. Two, the solution as what to do with the GSEs is too simple to put in a bill that is so complex that hardly anyone fully understands it. Three, polarity within the halls of Congress continues to restrict reasonable compromises and dialogue. And four, the people who could not see the financial crisis coming are the same people that are now dreaming up the solutions on how to prevent a similar type of crisis from happening again.

Congress has it backwards. The Greatest Recession since the Great Depression did not come about because of the “banks too large to fail” or because of overly complex derivative instruments that no one really understood. The real problem that led us into the recession was the outright negligence and failure of those in charge of our economy (including the Federal Reserve, Treasury Department, OFHEO, Congress, etc.) to understand the fundamentals of basic housing finance and the operations of our beloved GSEs.

Because our leaders lack understanding of: (1) fundamental amortization principals; (2) the hidden economic power behind long-term mortgage rate changes; (3) the way mortgage lenders and mortgage agencies make their money; and (4) the basic indicators over which they should be monitoring, the current financial reform bill fails to fix the problems that led us into the financial crisis.

Fannie Mae and Freddie Mac never worked for the Government or the people of the United States of America. They worked for themselves and their stockholders. The GSEs are not public corporations. They are private enterprises whose stock is still sold (although much more cheaply now than in the past) on the New York Stock Exchange.

Fundamental to any real financial reform is the elimination of the entire concept of Government Sponsored Enterprises. There is nothing fundamentally wrong with the concept of a mortgage-backed security backed by the U.S. Government and sold in the global financial marketplace. What is wrong, however, is the current concept which allows two companies that represent less than one percent of the Fortune 500 companies in America to determine how such a program is run and operated.

Real financial reform would abolish Fannie and Freddie and integrate all of their left over business and responsibilities into a small conservative government run agency—somewhat like Ginnie Mae--that is prohibited from purchasing their own securities.

New financial regulation would create a position that would put some respected financial person (not a political hack) in charge of the new Federal entity. When selecting this person, he or she should be treated like a Federal Reserve Chairman or Secretary of the Treasury.

All duplication of effort should be eliminated in the new entity. A new state-of-the-art Underwriting System should be developed to ensure that good fundamental lending requirements (e.g., debt to income ratios) are followed, while prohibiting false products such as “teaser” ARM loans, or REMICs, or marginal sub-prime loans.

True financial reform would seek new ways to incentivize mortgagors (e.g., shortening loan terms, prepaying principal) to reduce long-term debt. One way to do this is to establish within the new federal entity responsible for mortgage lending a 30-year 4.0% fixed rate mortgage program for the “primary homes under $500,000” of highly qualified American citizens.

More than 85% of our current mortgage debt is good debt--held by the people who continued to make their regular monthly principal and interest payments while their leaders ran around nakedly confused. These are the people that truly saved us from a Great Depression and it is time to reward them through real financial reform

One last refinancing cycle to 4.0% for 85% of our mortgage debt in America, if implemented correctly through true financial reform would: (1) add $100 billion in annual stimulation to our economy without taxing and government spending; (2) increase homeowner equity to the tune of $1.6 Trillion; and (3) actually lead to reduction of U.S. Mortgage Debt and U.S. National Debt.

Now that would be real financial reform.