Do We Have a Chance at Housing Finance Reform?

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For decades, the Federal National Mortgage Association, or Fannie Mae, and the Federal Home Loan Mortgage Corporation, also known as Freddie Mac — both publicly traded companies — have expanded the availability of home mortgages by “packaging” the loans into mortgage-backed securities that investors can buy. This practice has allowed lenders to reinvest most of their assets and offer more loans. The financial backstop for Fannie Mae and Freddie Mac had always been an “implied” obligation of the U.S. Treasury to ensure that they would not be allowed to fail.

In September 2008, there was concern that the liquidity of Fannie Mae and Freddie Mac was insufficient to handle rapidly growing delinquency rates, primarily from subprime mortgages — loans issued to borrowers with low credit ratings. As a result, the Federal Housing Finance Agency placed Fannie Mae and Freddie Mac into conservatorship and the U.S. Treasury committed $200 billion to increase their liquidity.  The “implied” guaranty had become an “explicit” guaranty, and U.S. taxpayers were firmly on the hook.

This was the first in a string of events that rattled global financial markets.  By Sept. 15, 2008, the Lehman Brothers holding company had filed for bankruptcy and Merrill Lynch had accepted a government-promoted offer to be purchased by Bank of America. American International Group, one of the world’s largest insurers, was downgraded and a “rescue line” of $85 billion was issued by the Federal Reserve in exchange for 79.9 percent of AIG’s stock.  Home prices plunged, foreclosures skyrocketed and millions of Americans lost their jobs. The Great Recession had begun.

These events and similar transactions under the Troubled Asset Relief Program, passed by Congress and signed by President George W. Bush in October 2008, resulted in billions of dollars of mandated federal loans to many financial institutions with “significant operations” in the United States. They represent the largest federal intervention in financial markets.   

But thanks to the U.S. Treasury’s commitment of $200 billion and the imposition of much more demanding loan restrictions, the residential real estate financing system stayed intact. Fannie Mae and Freddie Mac remained solvent and continued to operate, but their individual shareholders were wiped out. All the money borrowed from the federal government, plus a healthy bonus, has since been repaid to the U.S. Treasury. Without FHFA intervention, the Great Recession could have become America’s second Great Depression, and homebuyers would have kissed the 30-year fixed-rate mortgage goodbye.

Now, roughly nine years later, Fannie Mae and Freddie Mac remain wards of the federal government. Despite lots of rhetoric about government involvement being inconsistent with a free enterprise system and the ability and willingness of private lenders to fund residential mortgages without government involvement, more than 90 percent of all mortgages are still sold to what are essentially agencies of the U.S. government. 

Today, there are three competing concepts as to how to return Fannie Mae and Freddie Mac to private ownership. The first is the Libertarian approach: “Just let private capital step in and let’s see what happens.” While the idea of turning the residential mortgage finance system over to the private investment banking industry has some appeal, such entities have been inconsistent market participants. In the early part of the Great Recession, private capital almost totally withdrew from funding private mortgage-backed securities. As a result, there is concern that reliance on private mortgage-backed securities and private guarantors would mean that the liquidity of mortgage assets would be missing when most needed. 

The mortgage market liquidity provided by entities such as Fannie Mae and Freddie Mac is part of why the U.S. housing finance system is a global model. Because of the size of the U.S. market and our desire to be able to offer long term fixed rate loans, there is a role for the federal government in housing finance.

A second approach to restructuring Fannie Mae and Freddie Mac is being promoted by the large hedge fund owners of the Fannie and Freddie stock. Their idea is to “recap and release” — or to recapitalize the two entities, release the stock to private investors, and provide some regulatory oversight.  

The concern is that this approach would allow private owners to take advantage of another implicit taxpayer guaranty if things went wrong again. Ed Pinto of the American Enterprise Institute, who has written extensively on Fannie Mae and Freddie Mac, argues that we cannot put the taxpayer at the mercy of potentially weak regulators.

A third option has been endorsed by the Mortgage Bankers of America and others who have studied the situation. They argue for an approach that they believe allows for constant mortgage market liquidity, a 30-year fixed-rate loan, and reliable and responsible underwriting standards. Their proposal is to create, at least initially, two utilities that capitalize on the existing Fannie Mae and Freddie Mac organization, utilize an explicit federal guarantee paid for by individual borrowers in the form of a guaranty fee, and use existing private credit enhancement providers as second and third levels of credit protection. Only after all private guaranties are depleted would the U.S. Treasury cover “catastrophic” losses. These utilities would be highly regulated and provide a targeted rate of return to investors, similar to the way that many electric utility co-ops are organized today.

The consistent flow of mortgage capital is important to our nation as a whole — including those of us who are fortunate to live here in Beaufort County.


Elihu Spencer is a local amateur economist with a long business history in global finance. His life work has been centered on understanding credit cycles and their impact on local economies.  The information contained in this article has been obtained from sources considered reliable but the accuracy cannot be guaranteed.