DEC 3, 2013

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What We're Hearing

Privatizing Fannie and Freddie: Beware the Russian Model

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WE’RE HEARING advocates of “privatizing” Fannie Mae and Freddie Mac might want to bear in mind how the privatization of industries in Russia turned out. In short, not good.

Russian citizens—nominal shareholders as industries were privatized—ended up holding an empty bag. Russian oligarchs swooped in to buy up shares cheap and reap in billions in gains.

I couldn’t help thinking of the example of “Russian bear markets” when I read recently that William Ackman’s hedge fund Pershing Square Capital was buying a 10% stake in the common shares of Fannie Mae and Freddie Mac.

Ackman says he looks forward to negotiating with management, the board and the federal government to help shape the future of the GSEs.

My guess is that Ackman’s point of view in those negotiations will reflect his own financial interests rather than the public interest.

He’s not the only private investor with an appetite for helping to take the GSEs assets out of government conservatorship. Bruce Berkowitz’s firm, Fairholme Capital Management, has offered to buy the GSE’s insurance assets and has some of his own thoughts about GSE reform.

Berkowitz and some other investors, already investors in the preferred shares of the GSEs, have challenged the Treasury Department’s policy of capturing all the dividends of the GSEs to the federal government, given that the conservatorship status of the GSEs left 20% of the ownership in private hands, a move that apparently was designed to avoid adding the GSE’s immense obligations to the federal debt on the nation’s balance sheet.

Though members of Congress have thrown cold water on Berkowitz’s proposal and Ackman’s stake is not large enough to diminish the federal government’s control of the GSEs, my fear is that these investors with a sudden interest in helping resolve the future of Fannie Mae and Freddie Mac could end up with a sweetheart deal to buy cheap and sell high later in a “privatization” of the enterprises.

In the wake of the housing crisis, leaders of both political parties—in a rare show of bipartisanship—agreed that the GSEs should gradually be phased out of existence, though opinions differed as to what role the federal government should play in the mortgage market in a post-Fannie and Freddie world.

Now, with the GSEs back in the black and paying huge dividends to the government, that consensus seems to be fraying. Moreover, few think Congress and the Obama administration have the political will to undertake GSE reform in the near term.

Increasingly, it looks likely that meaningful action is unlikely until after the 2016 presidential election.

That may not be such a bad thing, in my judgment.

The appetite that some savvy billionaires have for a stake in the GSEs is evidence that I’m not the only one who thinks they still can play a meaningful role in making affordable, long-term housing finance a reality for millions of homeowners.

About a decade ago, when Fannie Mae and Freddie Mac first came under fire because of accounting scandals, calls for “privatizing” or eliminating the GSEs started to gain some currency in Washington. I remember talking to a stock analyst at the time, who suggested that Fannie Mae and Freddie Mac in the future might look a lot like electric utility companies today—heavily regulated, privately traded, dividend-paying stocks that appealed to “widows and orphans” rather than the growth oriented investors.

Such a future makes a lot of sense today. By regulating the amount and degree of credit risk the enterprises can take on, consumers would continue to benefit from the types of financing enabled by the GSEs, while the risk of catastrophic failure could be minimized. The GSEs in the future should not be able to invest in “subprime” mortgages, a growth gambit that didn’t work out so well during the housing bust. In addition, the enterprises should be required to hold more capital against losses than in the past.

Three years ago, the Urban Institute—a liberal-leaning think tank sympathetic to the government’s role in promoting homeownership—published a paper that didn’t endorse any particular reform proposal, but it did back the concept that the federal government should continue to play a role in the mortgage market.

That white paper argued that it was subprime lending and the private-label MBS market that fueled the housing bubble, not the GSEs. Reforming or eliminating the GSEs without putting a tighter leash on private-label financing would do little to prevent another crisis, the Urban Institute says.

In my view, there’s a big risk that Congress will throw out the baby with the bathwater in resolving the conservatorship of Fannie and Freddie.

If and when the GSEs or their successors return to private ownership, let’s hope it doesn’t happen in a way that enriches a handful of savvy billionaires at the expense of the taxpayers, as our Russian friends found to their dismay.

Some of the new investors say they want to unburden the government of its “implicit guarantee.” But privatized versions of Fannie Mae and Freddie Mac may still be viewed as “too big to fail,” meaning the implicit guarantee could be difficult to snuff out no matter who owns the enterprises.

Ted Cornwell has covered the mortgage markets since 1990. He is a former editor of both Mortgage Servicing News and Mortgage Technology.

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