Friday, June 4, 2010

Financial Reform and the Future of Fannie Mae and Freddie Mac

What is conspicuously missing from the over 1500 page financial reform bill passed by the Senate last month (SB 3217) or any of its more than 100 pages of amendments, is a clear strategy to exit Fannie Mae and Freddie Mac from their conservatorship and either dissolve or re-privatize these two entities. Traditionally Fannie Mae (The Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation) were public/private hybrids which meant that the U.S. government owned a minority interest in the two congressionally chartered, mostly private entities. In September of 2008, the U.S. government took both Fannie Mae and Freddie Mac into conservatorship in response to their huge losses, and since that time tax dollars have provided over $126 billion dollars to keep both entities open. Late last year, the Obama administration promised that it would cover unlimited losses through 2012 for both entities. (The pledged covered losses had been capped at $400 billion dollars prior to this.) Fannie and Freddie own or guarantee about $5.5 trillion dollars worth of U.S. residential mortgages or about 31 million mortgages, and in spite of recent credit and underwriting changes, they remain key players in the housing industry.

Both entities have been blamed in part for the financial meltdown and the problems with the mortgage crisis. Sharp criticism rose early this year when regulators announced that the CEO's of both Fannie Mae and Freddie Mac could be paid as much as $6,000,000 for 2009--a year when they were under conservatorship.

Many lawmakers agree that it is time to stop the bleeding on these two entities, which still provide an estimated 50-70% of mortgage loans in the United States. An amendment was offered to Senate bill 3217 which would have forced lawmakers to begin exiting Fannie and Freddie from conservatorship. This amendment was voted down. The one which passed, proposed by Harry Reid (D. NV) for Chris Dodd (D. CT) and Blanche Lincoln (D AR) calls instead for a Department of Treasury Study on "ending the conservatorship of Fannie Mae, Freddie Mac and Reforming the Housing System." The study is to include such options as "the gradual wind-down and liquidation of such entities; the privatization of such entities; the incorporation of the functions of such entities into a Federal Agency; the dissolution of Fannie Mae and Freddie Mac into smaller companies, or any other measures the Secretary (of the Treasury] deems appropriate." Other matters that this study is to consider include ways to restructure housing finance in the US to ensure that consumers will be able to access "30 year fixed rate prepayable mortgages and other mortgage products that have simple terms that can be easily understood; the role of the Federal Housing Adminstration and the Department of Veterans Affairs in a future housing system; the impact of reforms of the housing finance system on the financing of rental housing; the role of standardization in the housing finance system, and the options for transition to a reformed housing finance system." The study is to be completed no later than January 31, 2011 and it is to be delivered to the Senate Committee on Banking, Housing and Urban Affairs and the House Committee on Financial Services.

It is interesting that a bill which spends hundreds of pages creating and detailing the role of a new Bureau of Consumer Financial Protection, which has not previously existed, could not find space to do more than call for a study of two entities that are currently bleeding U.S. tax dollars. Although the amendment is laconic in its treatment of Fannie and Freddie, statements made by Treasury Secretary Tim Geithner and Congressman Barney Frank (D MA), who has been a major proponent of financial reform, suggest that actually the government does have plans for Fannie and Freddie--they just aren't telling us what those plans are yet.

For instance, the January 22, 2010 issue of the Wall Street Journal quotes Frank as saying that "The remedy here 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." In March, Frank went further and was quoted in the Washington Post warning investors that "People who own Fannie and Freddie debt are not in the same legal position as Treasury bonds, and I don't want them to be." According to the article, Frank says that he wants investors to understand that the Fannie and Freddie are not as safe as the U.S. government. The statement was unnerving to market analysts who feared that international investors would shy away from purchasing the debt. But Frank's comments are interesting in light of the current debate over whether the mortgage giants (or their replacements) should be privatized or owned completely by the government. One point on which everyone seems to agree is that a public/private hybrid, which the entities were before conservatorship, does not work. Frank has publicly expressed his dislike of public/private hybrids and Treasury Secretary Tim Geithner echoed his comments via Politico on April 9, 2010 when he called the hybrid concept "unworkable."

But the chances for privatization are not looking good. Former Fannie Mae CEO Daniel Mudd testified before the Financial Crisis Inquiry Commission in April of 2010 regarding the financial collapse of Fannie Mae. During his testimony Mudd was asked whether the government should be involved in the residential mortgage business. Citing the U.S. government's involvement in 90% of mortgage loans, Mudd's response was that "the notion that you could go back to a fully private structure cannot be accomplished within our lifetime." A study by Standard and Poor's released in January reaches a similar conclusion--it would be nearly impossible to attract enough capital to replace Fannie Mae and Freddie Mac with self-sustaining private companies which would offer affordable 30 year fixed rate mortgages.

That just leaves the government. This makes the parameters of the study particularly interesting, especially in light of Barney Frank's comments that we need to abolish Fannie and Freddie and come up with "a whole new system of housing finance."

What would such a system look like? No one is saying. But in a January interview with the Wall Street Journal Tim Geithner said that the process would not begin this year. "It's just a complicated thing to get right... But we are completely supportive and agree completely with the need to take a cold, hard look at what the future of those institutions should be in our country."

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