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Fannie and Freddie Must Go

One of the priorities of Rep. Jeb Hensarling, Chairman of the House Financial Services Committee, is to end the conservatorship of Fannie Mae and Freddie Mac and let the private sector take the primary role in operating the residential mortgage industry.  No other country in the world has the equivalent of the hybrid government/private-sector model of Fannie and Freddie, which has already cost taxpayers more than $150 billion.

The private sector provides mortgages in practically every other major country with little difference between homeownership rate in the U.S. and other developed countries. The U.S. needs a new system that never places taxpayers at risk again, promotes homeownership at affordable levels, and transitions from the current model without disrupting the housing recovery taking place

Some positive steps have been taken. Federal Housing Finance Agency Acting Director Edward DeMarco has proposed combining the back offices of Fannie and Freddie to reduce costs and increase efficiency. The merged operation would be available for use by the government or sale to the private sector after Fannie and Freddie are gone. The GSEs' huge portfolios are gradually shrinking, and Chairman Hensarling will hold hearings on what to do with Fannie and Freddie.

Yet, concern still exists among some politicians and industry participants that the housing industry cannot prosper without government support. We disagree.

The U.S. cannot afford another financial crisis like 2008-9 – a crisis that started with subprime mortgages and would never have grown so large so as to threaten the whole U.S. economy if we had a market-based mortgage structure.

Subprime mortgages existed for decades. But they made up a very small percentage of the mortgage market until Fannie and Freddie reduced credit standards to gain market share and to meet low income and minority homeownership targets mandated by Congress. By 2007 nearly 50% of all mortgages originated in the U.S. were subprime and alternative-A types with Fannie, Freddie and other agencies guaranteeing about 70%, according to Edward Pinto of the American Enterprise Institute.

Without these government guarantees, the subprime bubble and the resulting financial crisis would not have happened. Bank regulators and industry experts warned Congress for decades about Fannie and Freddie and their increasingly large and risky portfolios, but Congress failed to heed the warnings.

The solution now is straightforward: abolish the public/private hybrid of Fannie and Freddie, sell or liquidate their existing business, and privatize the mortgage market.

This can be done in an orderly way in a few easy steps. Fannie's and Freddie's portfolios of mortgages should be sold at a rate of about $75 billion a year until they reach zero. The $625,000 size limit on new mortgages guaranteed by Fannie and Freddie should be reduced by $100,000 per year, so that Fannie and Freddie would be out of the mortgage guarantee business within six years. The liability for any outstanding guarantees should be managed by the conservatorship of Fannie and Freddie until they run off or are sold.

If the government still wants to be in the mortgage business for low income families or minorities, the liabilities should be on budget and transparent. The Federal Housing Administration can fulfill this mission.

Some speculate that without Fannie and Freddie mortgage rates would skyrocket and the 30-year, fixed-rate mortgage would be a thing of the past. We disagree.

Nonconventional or jumbo 30-year mortgages not guaranteed by Fannie and Freddie have existed for decades. In the decade preceding the financial crisis, the interest rate on these jumbo, non-conventional mortgages averaged just one quarter point higher than similar guaranteed mortgages, a difference of a little over $40 a month on a $200,000 mortgage. Shouldn't Americans, like homeowners throughout the world, pay an extra $40 or so per month so taxpayers aren't on the hook for hundreds of billions to bail out Fannie and Freddie? The additional interest is even tax deductible in the United States.

Some are understandably worried that this change may be too abrupt. If the market doesn't adjust fast enough after the process starts, it can be slowed so the transition takes longer.

The U.S. mortgage market should be privatized. It's time for Congress to do what it should have done decades ago and give the FHFA a clear road map so that it can manage the process at the lowest cost to the taxpayer and with a smooth transition to the private sector. Get the government out of the mortgage business so taxpayers are never again at risk.

Richard M. Kovacevich is the retired chairman and CEO of Wells Fargo.  William M. Isaac, former chairman of the Federal Deposit Insurance Corp., is a senior managing director and global head of financial institutions at FTI Consulting, the chairman of Fifth Third Bancorp, and author of Senseless Panic: How Washington Failed America.  


(7) Comments



Comments (7)
More power to new thinking vs.incremental thinking. We need to take aggressive "other people's money" risk takers out of the financial sector and place thoughtful "do your homework" risk takers into government positions
Posted by Allan Grody | Thursday, March 21 2013 at 10:04AM ET
Dream on. Congress will never have the guts nor the incentives to liquidate Fannie and Freddie or their mortgage portfolios. Does anyone else see the scandal in the idea (that analysts are floating) of allowing GSEs to recapitalize themselves by claiming tax deductions against prospective income and booking an asset generated by losses that taxpayers have financed? Wouldn't this just pick another of the taxpayer's pockets?
Posted by Edward Kane | Wednesday, March 20 2013 at 3:49PM ET
Good on the authors for refocusing attention on the actual key cause of the 2008 crisis. It is indeed high time we abolish - not downsize - the only two institutions that really are TBTF.
Posted by Louise Bennetts | Wednesday, March 20 2013 at 2:46PM ET
I can understand Wells Fargo's thoughts, it certainly makes it more difficult for small community banks to compete and gives them the opportunity to do what they want without us taking away their business.

I respect Wells Fargo and think they are a very good bank, but it is another example of the way to lose more community banks, which I don't think is good for America's small businesses.
Posted by kenp | Wednesday, March 20 2013 at 12:34PM ET
Abolishing the secondary mortgage market is certainly in the interest of Wells, the 800lb gorilla, that controls 40% of the mortgage market! But how about community banks? The last time the big banks 'privatized' the mortgage securitization business, they created the Great Recession. Don't throw out the baby with the bathwater. Reform the secondary mortgage market system but don't abolish it. Main Street needs a continuous source of mortgage money as does our economy.
Posted by andkel | Wednesday, March 20 2013 at 12:16PM ET
Fannie and Freddie didn't create the financial crisis alone, but it is unlikely to have occurred without them and politically determined housing quotas. Their recent return to profitability is not surprising for a government monopoly refloated on the Fed's new housing bubble, but also not a reason to keep them.
Posted by kvillani | Wednesday, March 20 2013 at 12:12PM ET
As a former Fannie Mae Director, I could not agree more. The internal workings of this GSA are a dysfunctional bureaucratic mess that is more concerned with production metrics and self preservation than effectively managing the real world, real time morass that is the foreclosure / REO debacle.
Posted by Irishguy | Wednesday, March 20 2013 at 12:11PM ET
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