WASHINGTON — Support for carving up Fannie Mae and Freddie Mac into separate good and bad banks lasted less than 24 hours, with the Obama administration insisting this is not its plan and critics arguing the idea was complex and a tough political sell.
White House Press Secretary Robert Gibbs flatly denied press reports that the administration was pursuing such a plan, calling it "light years ahead of any decision-making process here." Another administration official, speaking on condition of anonymity, said the idea was one of many, including privatization or permanent nationalization, and that no solution had emerged as a front-runner.
It quickly became clear that the only person advancing such a plan was Federal Housing Finance Agency Director James Lockhart, who confirmed Thursday that he is planning to resign this month. He argued that such a solution would help rid Fannie and Freddie of its worst holdings, which would continue to be held by the government, while letting the government-sponsored enterprises return to the mortgage market.
"The point is how they exit conservatorship," Lockhart said in an interview.
The government would continue to provide "support for the debt- and mortgage-backed securities" but let the GSEs focus on their best holdings.
Many critics jumped all over the plan, however, raising questions about how it would actually work, including the structure of the good and bad banks, and there was widespread agreement the idea would have little political support.
Many said Congress would reject the plan because of the potential cost of a bad bank's holding some of the worst assets from the GSEs.
"Their portfolio is $1.5 trillion, and it's falling apart," said Paul Miller, a managing director of Friedman Billings Ramsey & Co. "I've seen estimates of $100 billion apiece in bad assets. … We know performance is a lot worse than we were led to believe."
The history of creating bad banks is also not encouraging. Regulators have struggled to develop a plan to remove bad assets from banks, and observers questioned how such holdings could be segregated at institutions that are far larger.
"It's not even easy in small or relatively easy cases," said Karen Shaw Petrou, the managing director of Federal Financial Analytics Inc. "Those are very complicated to do because of the moral hazard. Whom do you bail out? How do you do that? Take that into the context of $5 trillion [in debt], and it gets a lot harder."
It has been roughly two decades since Mellon achieved the last successful segregation of good assets from sour holdings, and many observers said the situation is far different for Fannie and Freddie.
"Mellon was able to pull off this division of the good bank and the bad bank because they had enough capital to finance the bad bank," said Lawrence White, a professor of economics at New York University's Stern School of Business. "What the bad bank did in Mellon's case was simply to allow managerial focus on bad assets. You isolate them and assign a set of managers and say, 'Work it out, guys.' "
But capitalizing good and bad banks for the GSEs is a murky task. With the government propping up the bad bank, it may still need to provide support for the good bank.
Lockhart said he hoped that a good bank, freed of all toxic assets, could instead be capitalized through private sources.
"It should be recapitalized and hopefully will be recapitalized in the private sector," he said. "Some people have talked more of a mutual ownership structure. That could be from financial institutions, or it could be going public again, or it could be private equity, for that matter."
But others doubted a good bank could be successful without at least some government support. For one thing, assets sold through the bad bank might not rake in enough money to give the good bank a sufficient cushion.
"The assets are going to sell at a real value, which is very low," said Joseph Mason, a finance professor at Louisiana State University. "It's not clear that that will be sufficient to provide a going concern that's well capitalized and sound enough."
It remains unclear who would buy the bad assets and at what cost. But Petrou said the holdings could be sold through the Treasury Department's Public-Private Investment Program.
"Fannie and Freddie are the ideal sellers into the PPIP," she said. "They have 30% of the subprime private-label mortgage-backed securities market, if not more these days. In conservatorship, they've ceased to care about what happens to their capital ratios."
Lockhart would not say whether this was a preferable path, but Petrou added that liquidating their bad holdings would also achieve other goals.
"It does what Treasury really wants," she said. "That's to liquidate the market. You force a seller into it. You start to set prices, and that gets the holdouts in the rest of the banking system to either recognize losses, write them down or sell them through PPIP and be done with it."
A fundamental question still facing policymakers remains what kind of form Fannie and Freddie should take once they leave government conservatorship. The administration faces the choice of privatizing the GSEs, nationalizing them or leaving them as they are, albeit with bolder lines between the responsibilities of government and the private sector.
Gibbs could not offer any timeline for a White House decision on how to proceed but reiterated that the issue is being considered as part of the broader effort to revamp financial regulation.
When asked how Fannie and Freddie should be resolved, the departing Lockhart would only say that they should not be left as nationalized institutions.
"I think the workable options are a much improved GSE structure … or a purely private-sector approach," he said. "But you may still need some sort of government catastrophic insurer because mortgage risk is so large at the catastrophic level that it may still be needed."