Military generals are cautioned to avoid fighting the last war; time and opponents have a way of producing new ways to contest a battlefield, catching unwary leaders off guard. When it comes to housing policy and political power, are Washington observers missing the next conflict?
Press cycles and political speeches focus on how to wind down or eliminate Fannie and Freddie, which may or may not, depending on who is talking, have precipitated the great housing recession. The public forum spends much energy on “how to make sure the GSEs never have their old power again.”
Mission accomplished, no doubt—the GSEs will be heavily regulated as public utilities, and never be allowed to retain the political muscle they once had. They will be “priced up” over some years to a more manageable size and limited to plain-vanilla product, with more modest top-executive compensation. But maybe that's the last war, not the next one. Maybe we're missing the real housing power going forward, an institution that, like the GSEs, once quietly provided the plumbing for large-scale finance while avoiding overt political behavior and battles. Maybe it's time to orient toward the real housing power in the land, both from a policy prescription basis and a raw dollar basis.
This new housing power today is the U.S. Federal Reserve.
First, some background. What's hard to remember now is once upon a time the GSEs were studiously in the political middle, careful not to antagonize one party or the other. David Maxwell, a Republican from Philadelphia, ran Fannie Mae quietly and handed over the reins in 1991 to Jim Johnson, a Democrat from Minnesota. The supposition was that Johnson would continue occupying the quiet middle, staying away from campaign politics and ultimately handing the GSE reins back to a Republican. The supposition was famously wrong.
Once the GSEs became something other than noncontroversial finance infrastructure providers, their political risks rose. The most crucial political mistake made by Johnson was Fannie Mae's decision in 1996 to publicly oppose presidential candidate Steve Forbes' flat tax idea.
In the midst of Forbes' run, Fannie Mae decided to weigh in to protect the mortgage interest deduction, as Forbes' platform would have degraded or eliminated this deduction. Whether the policy was right or wrong is not the point; observers were stunned the congressionally chartered corporation entered the presidential fray at all; Forbes' team never forgot it, and the altercation colored perceptions of the GSEs that never went away. (And earned the GSEs a lifelong enemy in Gretchen Morgenson, press secretary to Forbes then and now the author of “Reckless Endangerment,” a book that—who said Washington was a place of long memories and score settling?—controversially fingers Johnson as a major architect of the mortgage meltdown.)
In many ways the GSEs' political fate was sealed when Johnson left the CEO position but appointed another Democrat in his place. Republicans didn't view the GSEs as neutral financiers anymore.
In January—as the 2012 presidential election swung into high gear—we witnessed a different congressionally chartered entity, the Federal Reserve, mount an aggressive, coordinated campaign to shift the housing policy debate in a different direction, and one largely in concert with Democratic policy stances in Washington.
Regardless of the technical merits of the Fed's arguments, the reality is it has aroused a new degree of ire from Senate Republicans, who have called the white paper campaign “absolutely egregious,” and the timing is, frankly, terrible for the Federal Reserve. It's one thing to push these policy prescriptions in a nonelection year; it's quite another to push them as the country enters the 2012 presidential arena in high gear. Longtime observers of the Fed have expressed exasperation at the apparent lack of political savvy, but that assumes the Fed actions are innocent of politics—and not everyone is buying that.
And to further outline the housing power and positioning of the Federal Reserve, ask yourself: What institution is now the single largest holder of GSE mortgage-backed securities? Fannie or Freddie in their own retained portfolios? A large Wall Street TARP bank? A Saudi prince? No. It's the New York Federal Reserve, which currently holds roughly $900 billion of so-called agency MBS, dwarfing Fannie and Freddie combined, and almost as much as that held by all U.S. banks. News out this month is this portfolio may jump significantly larger. Never mind that the Fed once criticized the GSEs for holding (hedged for interest rate risk) retained portfolios; the Fed has gone one better by ballooning out a gargantuan position, with wider duration risk. Yesterday's arguments: they're for yesterday apparently.
And as the GSEs' regulator was once unable to reign in or adequately oversee the GSE portfolios, it's not clear what independent body can vouch for the safety of the Fed's $900 billion portfolio. (If interest rates diverge from models, which they must someday, what happens to the value of the Fed's holdings?) Yes, some disclosure exists, but these disclosure standards don't even merit a discussion—an impressive feat in a town where everyone has someone looking over the shoulder, and even regulators have inspectors general checking them.
Then there's the question of how long the Fed will hold this supersized retained portfolio. The Washington consensus might be for the Fed, Fannie Mae and Freddie Mac to all divest their retained portfolios, but we quickly run into a math and markets problem. Among the three the total dollar amount is roughly $1.4 trillion, or more than that held by all banks, and almost as much as held by all mutual funds, life insurers, and foreign entities together. How to sell this product into a liquidity-constrained market without undermining the bid and therefore the value in the process, not to mention causing a steeper rise in mortgage rates? (Or does the Fed simply hold its MBS to maturity, avoiding mark-to-market issues, but ensuring a long holdings' tenure?) And which organization would go first? Would the Fed move first, which effectively prevents the GSEs from selling until the market absorbs the Fed product, or do the GSEs move first, which effectively locks in the Fed's portfolio for some time? A reasonable person might conclude that the Federal Reserve, at a minimum, will be a substantial holder of mortgage-backed securities for many years to come. If the market appetite remains weak, due in part to Basel III requirements, and new players do not emerge to absorb this product, a reasonable person might conclude that the Fed has a permanent retained mortgage portfolio.
So the Federal Reserve is in many ways the new Fannie Mae. It has immense political power, a huge mortgage portfolio not overseen by any independent regulator, and the sense that its housing opinions must be taken into consideration, even in the midst of a white-hot political season. Its denizens can't imagine they might be overstepping here. The case history of the GSEs might be instructive to them.
Housing finance will always be a Washington topic, given the size of the sector and its importance to economic growth and mobility. The wrinkle, the most corrosive nature of housing politics, comes when a Washington financial institution thinks it must inject itself into a presidential campaign season in the name of economic policy. The Federal Reserve has held its unique position for many decades and anchored the country's monetary infrastructure, but it must avoid the temptation to expand its power and get embroiled in an election season to the detriment of its future independence. Ron Paul gained 8% in New Hampshire in 2008; this month he got 23%, driven in part by young voters' avid interest. The Associated Press states his campaign garnered 46% of the under-30 age group in New Hampshire. The figure in Iowa was 48%. His more media-friendly son rises behind him; Washington gestation periods are long, but they are not infinite. Is the Federal Reserve paying attention?
Robert Zimmer is principal at TVDC, a financial services consulting firm in Washington.
