Fairholme Capital Management wants to lead a group in a $52 billion investment to buy insurance businesses from Fannie Mae and Freddie Mac, highlighting the question of whether the government should play a smaller role in mortgage finance.
The full proposal to buy parts of the government sponsored enterprises, available online, would answer calls from both Republican and Democratic members of Congress, and from President Barack Obama, for the private sector to play a greater role in the housing finance system, said a statement from Bruce Berkowitz, CEO of Fairholme. Freddie Mac and Fannie Mae are government-sponsored businesses that buy, sell and guarantee approximately two-thirds of America's housing loans. Bad loan investment pushed the companies close to bankruptcy in 2008, after which the government decided to seize control of Fannie Mae and Freddie Mac. The mortgage-finance companies took approximately $187 billion in government aid before returning to profit in 2013.
"Fannie and Freddie's business model was not consistent with insurance industry best practices," Berkowitz said. "However, in this country we fix valuable businesses by restructuring; we do not simply throw them away. Fairholme is prepared to do its part to help effectuate this restructuring and to be long-term owners of the insurance businesses, without the need for any Federal assistance or special federal status."
The proposal to buy parts of the government-sponsored entities would have to be approved by the Obama administration, along with other stakeholders of Fannie and Freddie. This may be politically complicated for Fairholme to achieve, in part because in July Berkowitz sued the government in the U.S. Court of Federal Claims claiming that investors in Fannie Mae and Freddie Mac should be compensated for changes to the bailout terms set for the government-sponsored enterprises, which he said damaged the value of their shares. Sens. Bob Corker, R-Tenn., and Mark Warner, D-Va., introduced a bill in June that would replace Fannie Mae and Freddie Mac with a new government agency.
Fairholme's proposal also raises numerous questions including what is the value of Fannie and Freddie if the companies did decide to go private, says Robert Shiller, co-creator of Standard & Poor's Case-Shiller Home Price Indices. In the long run Fannie and Freddie's role should be supporting low-income housing, but keeping the government in control of those enterprises could be a good economic guarantee for the housing market in the short-term, says Shiller, who is also a professor of economics at Yale University.
"In the long-term there is no reason for the government to be involved in housing. I think we should tilt our GDP toward other things that matter more, like medical research," Shiller says. "In the short term it's a stimulus measure and maybe it's a necessity that we should use it to forestall a recession because if home prices were to drop again that would harm confidence."
Government-backed loans guaranteed by Fannie Mae and Freddie Mac have become a cornerstone of the U.S. economy, but maintaining the credibility of that system is possible with a private sector deal, says Philip Swagel, a professor at the University of Maryland School of Public Policy. The benefits of having numerous banks purchase parts of Fannie Mae and Freddie Mac would be increased competition for mortgage loan rates and no one institution would be "too big to fail," Swagel says, referring to the famous phrase that rationalized the government's bailout of large finance firms. A positive compromise to keep the federal guaranteed loans could include the requirement that private banks spend their own money first before the government steps in and guarantees the loans, Swagel says.
"This [Fairholme proposal] is the beginning of what's needed, is private investors to take on housing credit risk in a variety of ways," Swagel says.