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What's So Hard About Winding Down Fannie and Freddie?

The Federal Housing Finance Agency acting director, Edward DeMarco, recently sent to Congress a strategic plan for the next phase of conservatorships of Fannie Mae and Freddie Mac. A new structure for housing finance requires congressional action, yet neither Congress nor the administration has come up with an acceptable plan in the three years since Fannie and Freddie were placed into conservatorship. It's far from clear that the DeMarco plan will get the job done.

Fannie and Freddie have received more than $180 billion in taxpayer support during the last three years, and taxpayers are likely to be on the hook for twice that amount before we're done. We need a plan that will preserve the value that currently exists with the agencies in order to minimize the taxpayer cost and one that never places taxpayers at risk again.

Subprime mortgages have existed for decades. But they were a small percentage of the mortgage market (well under 10 percent), until Fannie and Freddie reduced credit standards to increase market share and meet low income and minority home ownership targets mandated by Congress. By 2007 nearly 50 percent of all mortgages originated in the U.S. were subprime with Fannie, Freddie and other agencies guaranteeing about 70 percent.

Without these government guarantees, the subprime bubble and the resulting financial crisis would never have happened. Bank regulators and industry experts warned Congress for decades about Fannie and Freddie and their increasingly large and risky portfolios.

Because Congress failed to act, nearly the entire developed world is suffering from the mortgage-induced recession. Taxpayers are on the hook for hundreds of billions of dollars of losses at Fannie and Freddie – dwarfing the losses from banks, Wall Street, auto companies, insurance companies and all other bailouts combined.

We don't understand why reform of Freddie and Fannie is taking so long and what all the angst is about. The solution is straightforward: the public/private hybrid of Fannie and Freddie should be abolished, their existing business sold or liquidated, and the mortgage market privatized.

This can be done in an orderly way in a few easy steps. Fannie's and Freddie's existing portfolio of mortgages should be sold at a rate of about $75 billion a year until it reaches zero. The current $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 guarantee business within six years. The liability for any outstanding guarantees would be managed by the current government 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, it should be on budget and transparent. There already exists a government organization to do this – the Federal Housing Administration.

Some say this would put at risk the American dream of home ownership. We disagree. The United States is the only major country in the world where the government is heavily involved in the mortgage market. Yet, home ownership percentage in the United States is only slightly higher (a percent or two) than most other developed countries, while countries like Canada have higher percentages than the U.S.

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. Non-conventional 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 of one percent 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 a tax-deductible $40 or so extra per month so taxpayers aren't on the hook for hundreds of billions to bail out Fannie and Freddie?

It's clear that we need to abolish the public/private mortgage model as represented by Fannie and Freddie. The U.S. mortgage market should be privatized, as it is in other developed countries.

It's time for Congress to do what it should have done decades ago and give the FHFA a clear roadmap so that they can manage this process at the least 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 & Company. William M. Isaac, former chairman of the Federal Deposit Insurance Corporation, is senior managing director and global head of financial institutions at FTI Consulting, chairman of Fifth Third Bancorporation, and author of Senseless Panic: How Washington Failed America. The views expressed are their own.


(8) Comments



Comments (8)

The article suggests political gridlock is responsible for the lack of movement on GSE reform. Ironically the article itself is engaged in a partisan argument intent on blaming the GSEs versus the "private" market (too big to fail = implicit guarantee?). While it is not reasonable to suggest we can remove political implications from this discussion (what could be more political than housing policy?), it would be helpful to dispense with the blame game. There is plenty of it to go around.

That the GSEs engaged in subprime is certainly not up for debate. Why they engaged in it is very much a central dividing line in this conversation. The hybrid structure of the GSEs is widely held responsible as they needed to compete with Wall Street for market share. (earnings vs. public mission, etc.). But the argument that Congressional mandates for minority home ownership is responsible doesn't pass the smell test. Low income and minority borrowers are a rounding error in the origination figures during the boom years. Fannie and Freddie spent enormous amounts of money lobbying Congress to get into the game fueled by a market awash in money looking for higher yield. "Homeownership" goals would provide political cover for throwing underwriting standards and leverage thresholds out the proverbial window. Politicians either bought the cover or were simply bought. Meanwhile consumers speculated and leveraged real estate to compensate for declining real wages and standard of living expectations.

One of the central positions of the article--that because the GSE's were required by Congress to buy subprime, the private market was obliged to supply it--provides a solid argument why the private market left to its own devices is in no way superior to the GSEs in providing liquidity to the housing sector. But that begs the larger question: what is the appropriate economic and social role of housing in our society? How one answers this central question will inform the appropriate means and efficacy of public policy and private market regulation. Simply reassigning the role of market liquidity from the GSEs to private companies obscures the larger question our nation faces as we reassess our values and balance sheets: is homeownership a means to social stability? A tool for wealth creation? Another widget in a world of traded commodities? Or an ideal now unattainable or inappropriate for a new reality?
Posted by David D | Thursday, March 08 2012 at 7:51PM ET
The authors ask why Congress has failed to address GSE reform (or the administration, for that matter).

The answer here is well-known. As much as we like to chalk everything up to partisan discord, the battle here transcends party lines. Some very powerful housing interests -- for perfectly legitimate reasons -- fear that taking the government out of the mortgage market will raise home prices. Groups like the National Association of Realtors and National Association of Home Builders want to ensure GSE reform doesn't kill the market. Whether you agree with them or not, their lobbying power is substantial (Every lawmaker, for example, has Realtors in their district). As a result, even the GOP caucus is split on what to do. In short, there is virtually no chance of seeing a bill this year, and even when Congress gets around to it next year, it's likely to be a long and bloody fight.
Rob Blackwell, Washington bureau chief, American Banker
Posted by rblackwe | Thursday, March 08 2012 at 3:41PM ET
Great article by Messrs Kovacevich and Issac, I am glad to see that this issue is finally being discussed. The recovery of the housing market is dependent on getting a private market solution to replace the Fannie & Freddie stranglehold on the secondary mortgage market.

The mortgage and real estate industry needs to get behind Rep Scott Garrett's Private Mortgage Market Investment Act. American Banker 01/12/2012 Replace GSEs with Private Investors, Pass the Garrett Bill - Bank Think Article - American Banker
Posted by RichardBooth | Thursday, March 08 2012 at 12:25PM ET
What am I missing? I'm no GSE fan, but they should not shoulder the entire blame. Maybe not even half. From where I sit, the private label market - not the GSEs - were the main culprits. I don't like the government running the entire secondary mortgage market, but don't want to see everything go private. The private label securitizations were the subprime and no-doc loan kings. They had over half the share of the secondary market before things started to crumble in 3Q 2007. I suspect the people that want to lay the entire blame on the GSEs are the same ones that want to see them replaced by another private label market. Frankly, I'm not convinced the folks behind the private label securitization market of 2004-2007 can be trusted to have a second chance.
Posted by Querp | Wednesday, March 07 2012 at 6:27PM ET
I have an idea... Let's abolish FHA, too. Then, without any housing finance system, except for the few loans that get made to wealthy people with lots of cash, we can have a 1930's style depression, instead of the 2008 style depression.

Let's face it - most people don't understand that this crisis was caused by anemic (at best) oversight by the Fed (allowing banks to make no-documentation loans) and the SEC which failed to correctly supervise the rating of mis-labeled MBS/CMO/ABS. We are allowing the same people to regulate a solution???

The lenders and banks that created this crisis are LONG GONE (they disappeared with the money too) Do you really want to punish the participants who played by the rules all along? That's who's left in the mortgage lending business - the honest players.

This is like saying that the steroid users in sports were a bad thing, so let's abolish sports.
Posted by tmortgan | Wednesday, March 07 2012 at 5:15PM ET
Private does not mean no bailout in the future - $45B at BOA, $50B at CITI, $30B at Bear, not to mention AIG and all the others. The $645 spent on TARP still outpaces Fan & Fred. F&F's hybrid structure did eventually lead to their failure. Looking for a simple fix? Return to a structure that proved it can work by removing F&F's ability to sell public stock. Only those who sell to F&F can hold stock and they will be required to do so in an amount proportionate to the guarantees outstanding. Also, severely limit F&F's ability to shelf loans - no long term holds, only temporary while accumulating for securitization. This structure worked for many years at F&F and still works at the FHLBs. It was the government, looking for a low cost bailout of the thrifts, that allowed the public sale of F&F stock that started them down the road to where they are now.
Posted by ricpfi | Wednesday, March 07 2012 at 3:47PM ET
Bravo to the authors of the article, and to Neil Weinberg.
Posted by GMahler | Wednesday, March 07 2012 at 3:43PM ET
It's a sad reflection on our political system that the financial crisis led to laws like the Durbin Amendment to Dodd-Frank that had nothing to do with causing the calamity while major culprits Fannie and Freddie remain intact wards of the state. Rather than learning its lesson in the GSE's collapse, our government compounded its folly by cranking up the role of the Federal Housing Administration in backing home loans that make no economic sense. If, as appears increasingly likely, the FHA needs a bailout, we won't be able to say this one snuck up on us. Neil Weinberg, Editor in Chief, American Banker.
Posted by Neil Weinberg | Wednesday, March 07 2012 at 2:21PM ET
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