Congress has long debated replacing Fannie and Freddie, who were at ground zero of the 2008 crisis as federally charted privately owned companies. They’d been given directives by Congress to make housing affordable, which pretty much meant: fulfill the American dream by having a chicken in every pot, a car in every driveway and a home for every American family – whether they could afford it or not.
They were thus incented to purchase mortgages with loose credit criteria at the behest of Congress. However, they also purchased many, many mortgages which did not even meet that low bar of creditworthiness, relying solely upon fraudulent representations by many of the selling banks that the mortgages met the credit guidelines. This enabled Fannie and Freddie to make huge profits, with Franklin Raines, then CEO of Fannie Mae profiting to the tune of over $90 million in salary and bonuses while he was at the helm!
Then, when they started taking large losses in 2008, they were bailed out, placed into conservatorship and then effectively nationalized with the Treasury taking all of their earnings (for discussion, see here and here).
Last year the Senate Banking Committee held hearings on housing and financing reforms with the expectation of producing a bill this year to determine the fate of Fannie and Freddie. Finally, something is shaking loose the logjam the two have been in.
In a position document and letter titled the “Federal Housing Finance Agency Perspectives on Housing Finance Reform,” sent to the U.S. Senate Committee on Banking, Housing and Urban Affairs last Tuesday, Federal Housing Finance Agency (FHFA) Director Mel Watt made the case for turning the government-sponsored enterprises (GSEs) Fannie and Freddie into shareholder-owned utilities, and allowing for other chartered companies to compete against them in a heavily regulated system.
Responding to a request from Senate Banking Committee members, Mr. Watt outlined his most detailed views to date on housing finance reform and the role of Fannie Mae and Freddie Mac.
The seven-page document envisions a system where Fannie and Freddie, and possibly other competitors, purchase mortgages and package them into securities through a shared platform.
Mr. Watt suggested Fannie and Freddie could be reincorporated as private entities, owned by shareholders, and be governed by strong liquidity and capital requirements. The government would provide an explicit guarantee for catastrophic losses. In other words, they would operate like public utilities, including having a regulated rate of return, small and restricted investment portfolios, and have strong oversight by federal regulators. In essence, he is saying Fannie and Freddie should be utilities as are gas, water and electricity, all government controlled utilities and regulated to allow certain returns to shareholders.
The FHFA also supports the continuation of a government-guaranteed security which would have several layers of protection built into the system to shield taxpayers from risk. The utilities would be required to hold sufficient capital to cover losses during downturns, and also continue to offload risk to the private sector through risk-sharing vehicles. An insurance fund, which Mr. Watt favors, would ensure the bonds in the event of catastrophic losses.
Several financial groups applauded Mr. Watt’s paper. Mortgage Bankers Association President Dave Stevens had positive things to say about Watt’s ideas, noting, in particular, the MBA’s own proposal calls for a government guarantee behind mortgage-backed securities (MBS). The Independent Community Bankers of America (ICBA) also praised Mr. Watt’s stance on preserving the role of local lenders in originating mortgages, particularly in rural communities.
Scott Olson, executive director of the Community Home Lenders Association said: “I think this is extremely helpful,” … “They are the regulator and have been working with them for many, many years. So, it is extremely constructive to have their views and perspective.”
Craig Phillips, a senior counsellor to Treasury Secretary Steven Mnuchin, indicated Mr. Watt’s proposals are generally in line with Treasury’s thinking. And mortgage bankers called on Congress to get the job done as soon as possible.
Even retiring House Financial Services Chairman Jeb Hensarling, a vehement critic of the federal government’s role in housing, acknowledges that a government guarantee in the secondary mortgage market will have to be part of any solution that could make it to President Trump’s desk.
Should GSEs operate as utilities? Fannie and Freddie were in fact utilities at one time. In an American Banker article in 2016, Joshua Rosner stated that gas, sewer, water and electric utilities are all government-sponsored enterprises. Like Fannie and Freddie, they operate in essential industries that serve a public good and in which the cost of their infrastructure is too high to allow competition without supporting uneconomic outcomes.
He says, “If the goal of financial reform is to reduce risks to the public, we should use the time-tested and effective public utility model, rather than gamble on the same “too big to fail” model that brought us to crisis.”
Mr. Rosner points out that from 1992 until the 2008 financial crisis, the companies transformed from conservative utility-like entities into growth companies promising investors a 20% annual return. This led to further weakening of controls to maximize growth and profits. The financial crisis, when it arrived, decimated both companies.
As always there is more than one side to an issue.
Mr. Peter Wallison, an expert in the financial crisis, and the author of “Hidden In Plain Sight: What Caused the World’s Worst Financial Crisis and Why It Could Happen Again” is most concerned regarding (FHFA) Director Mel Watt’s “solutions,” saying, “Now, the bad news: The Treasury Department wants to return to the regulated market that caused the financial crisis. At first this might seem implausible. The aggressive deregulatory work of the Trump administration has stimulated the U.S. economy, but its Treasury Department is pushing for more extensive regulation of the housing-finance market.”
He believes, “Housing finance desperately needs reform, but Treasury is moving in the wrong direction—back to the 1930s.”
The battle for Fannie and Freddie continues to be a soap opera. Yes, housing does need reform. Is Mr. Watt’s directive the best answer? What does matter is that we must continue to have reforms and assure 2008 does not happen again. Does that mean more regulation or less? And what happens to the existing GSE shareholders, whose investments were rendered worthless when the Treasury started taking all the GSE earnings?
What to do about Fannie Mae and Freddie Mac has loomed over our administration for some time. In 2016, now Treasury Secretary Steven Mnuchin said ”We’ve got to get Fannie and Freddie out of government ownership. It makes no sense that these are owned by the government and have been controlled by the government as long as they have.”
Action, the right action, is needed.
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Richard Bowen is widely known as the Citigroup whistleblower. As Business Chief Underwriter for Citigroup during the housing bubble financial crisis meltdown, he repeatedly warned Citi executive management and the board about fraudulent behavior within the organization. The company certified poor mortgages as quality mortgages and sold them to Fannie Mae, Freddie Mac and other investors.
