The huge debt of Fannie Mae, Freddie Mac, other government-sponsored enterprises and Ginnie Mae fully relies on the credit of the United States. It is in fact government debt, but it is not accounted for as government debt. It is not "considered officially to be part of the total debt of the federal government," the Federal Reserve coyly notes.
Not "considered officially" — but agency debt has proven its ability to generate huge losses for the taxpayers. It is off-balance sheet debt and hidden leverage for the government.
In 1970, Treasury debt held by the public was $290 billion. Agency debt was minor by comparison: it totaled only $44 billion.
But by 2006, at the height of the housing bubble, while Treasury debt was up to $4.9 trillion, agency debt has inflated to $6.5 trillion. Treasury debt had increased 17 times during these years, but agency debt had multiplied 148 times!
In 1970, agency debt represented only 15% of Treasuries. By 2006, this had inflated to 133%. At that point, there was a lot more agency debt than Treasury debt — more government debt off-balance sheet than on it. To move debt off the balance sheet was a practice of many financial actors during the bubble, but the government was a champion at it.
If we add the on and off-balance sheet debt together, we can get a total of "effective government debt" (debt dependent on government credit) held by the public. See the graph, below, that compares this "effective government debt" with Treasuries — an instructive comparison.
Observe that effective government debt held by the public now totals nearly $17 trillion (this is not counting the intra-government debt held by the Social Security and other "trust funds").
The expansion of agency debt not only imposes risk and credit losses on taxpayers. It also increases the interest cost of Treasury's direct financing by creating a huge pool of alternate government-backed securities to compete with Treasury securities, a point Treasury debt expert Frank Cavanaugh was already worrying about in 1996.
Investors substitute agency debt for Treasuries. We can observe a striking example of such substitution in the aggregate balance sheet of the commercial banks.
In 1970, commercial banks owned $63 billion in Treasuries and $14 billion in agency securities. Their Treasury holdings were more than four times their agency holdings. By 2006, at the peak of the bubble, this had flipped in remarkable fashion. All commercial banks owned merely $95 billion in Treasuries, which was dwarfed by their $1.14 trillion in agencies. They then had 12 times the investment in agencies as in Treasuries.
At the end of 2010, the corresponding totals were $299 billion of Treasuries and $1.35 trillion in agencies. This long-term trend is shown in the second graph below.
What should be done now?
Make the Treasury Department truly responsible for managing all the government’s debt. Managing only Treasury securities deals with only about half, and sometimes less than half, of the effective government debt.
In contrast, in the 1970s, the Treasury Department was more actively involved with agency debt. That may be one reason agency debt was proportially smaller. In those days, for example, it demanded its approval of every individual debt issuance by the Federal Home Loan Banks, as required by the Government Corporation Control Act of 1945.
This act, which grew out of the sensible worry that government corporations were too free in using the credit of the United States, considered that the Treasury Department should be in control of the government's own credit and its use by agencies.
It defined among its terms "a mixed ownership government corporation," reflecting government ownership of some of the capital of the entity, as one category of government corporation — this category included and still does include the Federal Home Loan Banks. In fact, though not yet in law, this is what Fannie and Freddie are now.
The responsibility of the Treasury Department to control the debt of such corporations is spelled out by the act with notable rigor:
"Before a Government corporation issues obligations and offers obligations to the public, the Secretary of the Treasury shall prescribe –
(1) the form, denomination, maturity, interest rate, and conditions to which the obligations will be subject;
(2) the way and time the obligations are issued; and
(3) the price for which the obligations will be sold."
Quite a thorough requirement.
Since 2008, there is no doubt whatsoever that Fannie and Freddie have been and are mixed ownership government corporations. The bulk of their equity capital is owned by the government, although there are small residual private interests in common and junior preferred stock. They are clearly just the sort of government debt-generating organizations the Government Corporation Control Act is meant to control.
Congress should promptly amend this act to add Fannie Mae and Freddie Mac to its list of mixed-ownership government corporations, thus formally subjecting them to the discipline of the Act.
In addition, Treasury should be responsible for reporting to Congress on the cost to the Treasury created by the use of agency debt.
In this way, we could help control, for the future, the use of the government's credit card by agency debt, the consequent possibility of huge taxpayer losses, and the overleveraging of the housing sector which uncontrolled agency debt aggressively promotes.
Alex J. Pollock is a resident fellow at the American Enterprise Institute. He was president and CEO of the Federal Home Loan Bank of Chicago from 1991 to 2004.