It appears that Washington is finally getting around to grappling with the largest unresolved question left over from America's housing meltdown: What's to become of the government-backed mortgage giants, Fannie Mae and Freddie Mac? Their fate has been in limbo since the federal government bailed them out and put them in conservatorship in 2008.
Now, however, the two government-sponsored enterprises (GSEs) are reaping enormous profits as housing markets rebound. This has gotten lawmakers' attention. House Republicans have introduced a typically radical bill that would eliminate Fannie and Freddie altogether. A bipartisan Senate proposal would wind down Fannie and Freddie over five years and replace them with a similar functioning institution that charges a fee to insure loans in the event of catastrophic losses. And President Obama weighed in recently as well, saying it's time to end Fannie and Freddie “as we know them.” Though widely misinterpreted as a call to eliminate the GSEs, this artfully ambiguous formulation actually left the president a lot of wiggle room.
So Democrats and Republicans are laying out their opening positions in a crucial negotiation over the shape of America's future housing finance system. It's about time.
Clearly, we can't simply revert to the status quo before the housing crisis, when the GSEs (and their politically wired and lavishly paid executives) profited handsomely from the government's implicit guarantee of their securitized mortgage portfolios. Their structure enabled private investors to reap all the upside gains while exposing taxpayers to catastrophic downside losses.
So GSE reform is essential, but it shouldn't mean a death sentence. Without some kind of modified government guarantee, home buyers of modest means can kiss goodbye that sturdy prop of middle class home ownership: the 30-year, fixed-rate mortgage.
Shuttering the GSEs completely, as both bills call for, makes little sense. The idea that you can completely dismantle a housing finance infrastructure that is the foundation of an $11 trillion market is a fantasy the likes of which is only found in Washington. The likely outcome would be chaos, as banks and investors try to reconfigure trillions of dollars in mortgages they have sold into secondary markets with the help of Fannie and Freddie. Replacing the GSEs with some kind of similar institution would likely cost billions of dollars – making it one of the most expensive rebranding exercises in history.
Instead, a realistic debate would focus on how to reform the GSEs, while protecting taxpayers from future bailouts, preserving the 30-year fixed rate loan and reasonable down payments for the middle class. For that, reform should center on preserving the government guarantee. This is a nuanced but important difference to investors who buy GSE securities. Guarantees are absolute, while insurance has conditions that need to be met and can ultimately be rejected.
Here's another important reason why we shouldn't cavalierly junk Fannie and Freddie. They have spent the last 70 years acquiring vast experience in housing markets and boast a cadre of highly skilled specialists in housing finance. All this human capital and market intelligence institutionalized in the GSEs have become necessary to market efficiency and order. How exactly do we replicate that in five years while beginning from scratch? Aren't all the people we will need to staff the new institution the Senate bill envisions already working at Fannie and Freddie?
Nearly everyone agrees on the need to reduce the government's oversized footprint in housing finance and bring private capital back into the market. Right now the GSE's account for more than 90 percent of new lending. But if you took a poll of actual mortgage investors, as opposed to free market ideologues, you'd find few who actually want to drive government out of housing markets altogether. They just want a chance to go back to work making loans and not have to be priced out of the market by Uncle Sam.
OK, so let's shrink the amount of loans by the GSEs by increasing the fee for guaranteeing the mortgage (g-fees) and slowly decreasing guaranteed loan amounts. All the while we can use those two simple levers as a countercyclical measure if more liquidity is needed.
Similarly, there's little clamor on Main Street for doing away with Fannie and Freddie. Last time I checked, middle class homeowners still prefer fixed-rate mortgages, low rates and affordable down payments to tight credit and ARMs. No doubt, the GSE bailouts were expensive, requiring an initial taxpayer infusion of $187 billion. But Fannie and Freddie have been reaping so much cash – more than $15 billion in profits from the twins last quarter-as homeowners refinance and people purchase new homes – that taxpayers will get all their money back and then some by 2014. What's more, the loans they are making are pristine, high-quality, plain vanilla loans. No systemic risk here and no angry mobs on the lawns of Fannie and Freddie.
The conservative's claim that Fannie and Freddie somehow caused the housing bubble is pure fiction. To be sure, it's not easy to serve two masters – private shareholders and the government – and the GSEs never charged properly for the explicit government guarantee they provided to banks. That problem has been fixed. The GSE's most stable business line through the crisis was multi-family lending, which never experienced heightened losses. Those departments are still going strong. And this is the most crucial point: The GSEs went awry by acquiring portfolios of risky loans in pursuit of ever escalating market returns. Thanks to new loan standards issued as part of the Dodd-Frank regulatory reforms, the GSEs will never be able to operate that model again.
So, if government still has to play a role in housing markets please explain again why Fannie and Freddie must be shut down or replaced by something that performs functions indistinguishable from theirs? It's time for all sides to acknowledge that government has an indispensable role to play in expanding middle class home ownership. That's why GSEs need to be fixed, not thrown out with the bathwater.
Jason R. Gold is director of the Progressive Policy Institute's "Rebuilding Middle Class Wealth Project" and senior fellow for financial services policy. Keep up with his work at PPI here and follow him on Twitter at @PPI_JGold.
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