Tackling the last piece of unfinished business from the 2008 financial crisis is a top priority for policymakers — the big question is how to do it.
Recently, an early draft of legislation aimed at reforming the twin housing giants Fannie Mae and Freddie Mac was made public. The proposed legislation, sponsored by Sens. Bob Corker, R-Tenn., and Mark Warner, D-Va., comes just weeks after Federal Housing Finance Agency Director Mel Watt laid out his own ideas about the future of the government-sponsored enterprises. At the same time, Treasury Secretary Steven Mnuchin has articulated three core principles for reform: protect taxpayers, end government ownership and preserve the 30-year mortgage.
Yet unlike Secretary Mnuchin’s and Director Watt’s stated policy preferences, the Corker-Warner proposal would continue to keep Fannie and Freddie in conservatorship until certain metrics of competition could be met.
As policymakers evaluate options, an enlightened blueprint for reform put forward by investment firm Moelis & Co. warrants close attention. The Moelis proposal leverages Fannie’s and Freddie’s profitably — they have already returned $276 billion to the Treasury since they were placed into conservatorship in 2008 — in to order rebuild their capital and release the enterprises from government ownership. Although Fannie Mae recently asked the government for $3.7 billion to cover its liquidity shortfall this quarter, the firm is on track for continued profitability.
Fannie and Freddie were privately-held companies prior to being seized during the financial crisis. Had the companies not strayed from their narrow mission of preserving liquidity and stability in mortgage markets, they would not have been nationalized. When it passed the Housing and Economic Recovery Act in 2008, Congress imposed key reforms on Fannie and Freddie, which have made them much stronger companies. Since then, they have returned their focus to their historical mission of providing access to affordable housing.
The fact that Fannie and Freddie have enabled private-sector lenders to offer products such as the 30-year mortgage and expand home ownership cannot be dismissed out of hand politically. Nor can the fact that they back some $5 trillion in mortgage debt.
Watt seemed to acknowledge these realities when he suggested last month that Fannie and Freddie should be reincorporated as private, shareholder-owned entities with an explicit government guarantee only for catastrophic losses in the secondary mortgage market. He wants the reconstituted GSEs to stick to their essential mission and not wade back into speculative pursuits that carry high risks.
Conversely, the draft Corker-Warner proposal adopts elements of a proposal favored by the Mortgage Bankers Association, notably the creation of private-sector mortgage “guarantors” to compete with Fannie and Freddie.
The new guarantors envisioned by the MBA plan would have a government backstop for mortgage-backed securities — something that has never been done before. Rather than reducing taxpayer risk and ending government ownership of the GSEs, this proposal would put taxpayers on the hook for guaranteeing all future U.S. mortgage securitization.
The Moelis blueprint, on the other hand, would fully compensate taxpayers for having propped up Fannie and Freddie and would end government ownership by raising new capital for the enterprises and protecting taxpayers from future bailouts. In essence, the Moelis plan focuses on building sound management practices and adequate capital levels at the GSEs, rather than trying to create alternatives to them.
A significant obstacle to any plan to eliminate Freddie and Fannie and replace them with private entities is amassing sufficient private capital. Ironically, some critics raise this same concern with regard to recapitalizing Fannie and Freddie. They question whether the issuance and sale of new GSE stock along with the sale of warrants the government now holds in Fannie and Freddie would raise sufficient capital to enable the GSEs to operate soundly.
I believe this skepticism is unfounded. At the height of the recent financial crisis, the government required the big banks it had rescued to raise capital by selling stock, and it worked to the tune of $185 billion. Today, there are much deeper pools of capital — certainly enough to recapitalize the large and profitable GSEs.
Fannie and Freddie have already returned nearly $280 billion to taxpayers on the $187.5 billion bailout. With the Dow recently passing 26,000 and tax reform now in place, Fannie and Freddie should not have significant difficulty finding investors.
If there was ever a time when capital markets are well positioned to be part of a long-term plan for Fannie and Freddie, it is now. GSE shareholders might finally have a chance to recover some value, average families could rest assured that home finance options will remain available and taxpayers would at long last be liberated from Fannie and Freddie’s fortunes.