Forbes: Washington Cannot Defuse The Ticking Time Bombs Fannie Mae And Freddie Mac

This is the fourth in an 11-part series on the failed promises of the Dodd-Frank financial reform package and the continued, dangerous imbalances in our financial system.

Fannie Mae (the Federal National Mortgage Corporation) and Freddie Mac (the Federal Home Loan Mortgage Corporation) were definitely players in the financial crisis. No one disputes that, but there are very different, usually partisan opinions about how much they contributed to the crisis and how to fix them. That’s no doubt why they aren’t mentioned in Dodd-Frank. The political divide on them might well have torpedoed the entire bill.
I’ll quote from both the majority and minority FCIC reports to frame the Fannie Mae-Freddie Mac problem. The majority report said, “These GSEs [Washington-speak for Government Sponsored Enterprises] had a deeply flawed business model as publicly traded corporations with the implicit backing of and subsidies from the federal government and with a public mission. Their $5 trillion mortgage exposure and market position were significant. In 2005 and 2006, they decided to ramp up their purchase and guarantee of risky mortgages, just as the housing market was peaking…
“They used their political power for decades to ward off effective regulation and oversight—spending $164 million on lobbying from1999 to 2008. They suffered from many of the same failures of corporate governance and risk management as the Commission discovered in other financial firms…
“Through the third quarter of 2010, the Treasury Department had provided $151 billion in financial support to keep them afloat…
“We conclude that these two entities contributed to the crisis, but were not a primary cause. Importantly, GSE mortgage securities essentially maintained their value throughout the crisis and did not contribute to the significant financial firm losses that were central to the financial crisis. The GSEs participated in the expansion of subprime and other risky mortgages, but they followed rather than led Wall Street and other lenders in the rush for fool’s gold. They purchased the highest rated non-GSE mortgage-backed securities and their participation in this market added helium to the housing balloon, but their purchases never represented a majority of the market.”
The minority report concluded: “The government-sponsored enterprises Fannie Mae and Freddie Mac were elements of the crisis in several ways:

  • They were part of the securitization process that lowered mortgage credit quality standards.
  • As large financial institutions whose failures risked contagion, they were massive and multidimensional cases of the too big to fail problem.
  • Policymakers were unwilling to let them fail because:
    – Financial institutions around the world bore significant counterparty risk to them through holdings of GSE debt;
    – Certain funding markets depended on the value of their debt; and
    – Ongoing mortgage market operation depended on their continued existence.
    • They were by far the most expensive institutional failures to the taxpayer and are an ongoing cost.
    “These two firms were guarantors and securitizers, financial institutions holding enormous portfolios of housing-related assets, and the issuers of debt that was treated like government debt by the financial system. Fannie Mae and Freddie Mac did not by themselves cause the crisis, but they contributed significantly in a number of ways.”

Since September 6, 2008, when Fannie Mae and Freddie Mac were placed in a conservatorship operated by the Federal Housing Finance Agency (FHFA), not much has happened to them. The political argument about how central they were to the financial collapse has never stopped, but it hasn’t led to any solutions. Both sides want to wean the $11 trillion mortgage market from its over-dependence on the government, but there has been no agreement about how that can be done. Congressional Republicans generally want to have the private market be completely responsible for mortgage financing. Many Democrats argue that reform is necessary, but some government involvement is necessary to ensure affordable mortgages for a wide range of Americans.
Complicating the issue is that both agencies have recently been extremely profitable. Fannie Mae posted a record profit of $17.2 billion in 2012; Freddie Mac earned $11 billion. That has been a windfall for the U.S. Treasury, but something of an embarrassment of riches for a federal government that, all sides agree, shouldn’t be that directly involved in the housing finance business. Given how dependent the market is on Fannie Mae and Freddie Mac (since 2008, government-backed agencies have insured nearly 90 percent of new mortgages), how can the government get out of the business without killing the housing recovery?
Late last month, Senators Mark Warner (D-VA) and Bob Corker (R-TN), along with three Republican and three Democratic co-sponsors who also serve on the Senate Banking Committee, introduced a compromise bipartisan bill that phases out FHFA, including Fannie Mae and Freddie Mac, over the next five years. It would create a new Federal Mortgage Insurance Corporation (FMIC), modeled after the FDIC, that would insure mortgages for lower and middle-income homebuyers but with restrictions that would greatly limit the government’s exposure and make private lenders and homeowners suffer first in the event of nonpayment. The FMIC would charge premiums to private mortgage lenders in exchange for its guarantees; the cost of the premiums would no doubt be passed on to homebuyers. The bill is complicated, but the bottom line is that higher down payments would be necessary but 30-year-fixed rate mortgages would still be widely available.
It took no time at all for the right to attack the bill. The Heritage Foundation said on its blog, “The federal government already plays the role of underwriter and guarantor through the Government National Mortgage Association, which serves targeted groups of potential homeowners who would not likely be served by the conventional mortgage market. The Corker–Warner bill would effectively place the remainder of the U.S. secondary mortgage markets under the FMIC—as the underwriter, regulator of mortgage-backed security issuers, and backstop to the entire system for all losses not absorbed by private capital.”
Last week, perhaps in a direct response to Warner-Corker, House Financial Services Committee Chairman Jeb Hensarling, (R-Dallas) introduced a “Republican only” plan that he described as “the GSE Bailout Elimination and Taxpayer Protection Act, to protect taxpayers from more GSE losses.” He said, “My bill would privatize Fannie and Freddie over a five-year transition period, gradually eliminating taxpayer subsidies in the secondary mortgage market.The legislation would begin implementing important reforms upon enactment, put a hard two-year end date on conservatorship and eliminate the government charters after five years. My legislation is supported by Heritage Action, Freedom Works, National Taxpayers Union, and the Council for Citizens Against Government Waste.”
Liberal Democrats were predictably aghast. House Financial Services Committee Ranking Member Maxine Waters (D-CA) said the Henserling bill “consigns future generations of homeowners to the types of high interest, balloon-payment mortgages that caused the financial crisis.” Julia Gordon of the Center for American Progress described it as “the ultimate right-wing wish list, turning the entire mortgage market over to Wall Street lock, stock and barrel.”
Given the bipartisan sponsors of the Senate proposal, I think there is a good chance that something like the Warner-Corker proposal will ultimately pass the Senate. The avowed single party nature of the Henserling proposal may allow it to pass the House. From my perspective, the odds of reconciliation in a House-Senate conference are virtually nil.
So it’s more than likely that when the next anniversary of Dodd-Frank comes up in July 2014, and immediately preceding the midterm congressional elections, Fannie Mae and Freddie Mac will still rest in the conservatorship of FHFA—and still be ticking time bombs waiting to explode at some future date.

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