The Obama Administration has solicited and received hundreds of letters advising it on what to do with Fannie Mae and its younger cousin Freddie Mac. Most have a similar theme, telling politicians what they want to hear, which is that we can keep Fannie and Freddie but with the caveat that they refrain from blowing up the global financial system again.
Many community bankers are probably thinking that they can live with Fannie and Freddie, at least those who survived the default on their preferred stock which the Treasury Department encouraged them to buy only a year earlier.
The savings and loans came to the same conclusion in the 1970s. But with both the savings and loan industry and Fannie technically insolvent by the early 1980s, Congress could only let one or the other grow out of their problem but not both. It chose Fannie, which continued to squeeze spreads on home mortgage loans. The Garn-St. Germaine Depository Institutions Act encouraged the savings and loans to go for broke with commercial real estate lending, which they did, ending up broke! Politicians blamed the owners and managers while protecting and promoting (and subsequently milking) Fannie.
Of course they will promise to be good corporate citizens in order to get their rebirth and freedom, and they undoubtedly will be for awhile. But commercial banks have never been able to compete with the government in funding mortgage loans, so Fannie and Freddie will take all the least-risky conforming loans and leave the riskiest for commercial banks to fund. The real irony is that most banks today are thinking shrink because they cannot generate sufficient assets on which to earn a respectable margin.
There are no legitimate public policy objectives served by reincarnating Fannie and Freddie, and arguably never were. Fannie Mae's Great Depression motivation was to create jobs by stimulating housing construction in spite of an 80% increase in vacancy rates between 1928 and 1932 and unemployment rates at times exceeding 30%.
Fannie and Freddie never changed the homeownership rate until the first half of the past decade when it went up about 4%. To do that, they had to resort to predatory lending.
Similarly, the U.S. mortgage market is so competitive that all qualified borrowers can find a loan. So what is with the multitrillion-dollar lending quotas imposed on mortgage markets by the federal government under the banner of affordable housing unless the intent is to fund unqualified borrowers? This is what pushed up housing prices making houses unaffordable to lower-income borrowers in the first place!
The notion that we need these enterprises to insure a steady flow of funds no longer has merit. The wholesale originate-to-sell system of finance came about as a result of massive regional migration of the population to the West and South that banks were prohibited from following because of branching restrictions. In addition, savings were flowing to institutional life and pension/retirement accounts, and securities laws limited access. The branching restrictions are long gone as are most of the capital restrictions. The pending covered bond legislation should remove the last of them.
The arguments that we need them for emergencies or to safeguard the continued availability of fixed-rate mortgages ignores the massive Ginnie Mae and Federal Home Loan Bank programs. These are less than perfect but much better than Fannie and Freddie, and we clearly don't need both.
The affordable housing advocates have been added to the original 1930s-era constituents of the home builders, real estate agents and mortgage bankers. They along with all the other housing constituencies would rather seek government preferential treatment than deal with bankers on market terms.
The administration is planning a conference on Fannie and Freddie for Aug. 17 to solicit additional industry views. Many economists likely will appear with their own plans. Fannie and Freddie treated this profession really well and made many friends, and economists love to design financial institutions and instruments, so they will undoubtedly unveil numerous plans for a new mission with a "limited" guarantee. The one place their ideas were actually implemented was at the hedge fund Long-Term Capital Management.
The Dodd-Frank Act followed past practice of absolving politicians and the regulators they oversee, blaming the lack of market discipline for systemic failure while ignoring the role played by Fannie and Freddie. Their debt is not now and never has been guaranteed by the government as their disclosures have made clear since 1938, but nevertheless has never been subject to market discipline. No mechanism to stop the politization and consequent risky growth of housing banks has ever been found.
This political theater is being produced and directed by the Treasury secretary and Federal Reserve Board chairman, newly empowered by Dodd-Frank as our two systemic regulators. These are the agencies that were asleep at the switch the last time as systemic risk grew to the breaking point. Bailouts worsen systemic risk, reinforcing the need to mitigate it up front. But their script calls for orchestrating the reincarnation of the main sources of that risk, most likely with some shallow lines about the need to protect the availability of fixed-rate mortgages and to retain them as a policy tool for emergencies. Following Chinese theater, there will be some trite lines recited as the curtain falls about regulating better in the future, and politicians will lead in the applause.
We either eliminate them now, or prepare for the inevitable sequel.