As policymakers debate what to do with Fannie Mae and Freddie Mac, they may feel as though they have been rear-ended by reality.
It might be helpful to consult a road map in existing law that shows a path for restructuring a government-sponsored enterprise that was dominant in its market, then sunsetting its federal charter. The path begins in 1996 when the Student Loan Marketing Association (Sallie Mae) proposed to the Clinton administration and Congress that the company's life cycle as a government-sponsored enterprise had come full circle. With its "mission accomplished," Sallie Mae worked with the government and other stakeholders to reinvent itself. Fourteen years later, the reinvention has been a success story.
Though many obvious differences exist between the current GSE conservatorships and Sallie Mae's situation, similarities exist, too. Like the mortgage GSEs, Sallie Mae had successfully pioneered a national secondary market. All developed standards for underwriting, financing and servicing models that supplied a business template for a developing marketplace of competitors, and they all grew by raising capital through stock sales to the public.
With keen competition for market share from both state agencies and other financiers, Sallie Mae confronted its own harsh reality in the early 1990s. Its narrow federal charter and undiversified source of income left its stock trading at liquidation value. Sallie Mae did not respond with activities that distorted the student loan marketplace but voluntarily pursued an "exit strategy" from government sponsorship.
Both HUD Secretary Shaun Donovan and Treasury Assistant Secretary Michael Barr have now publicly rebutted the urban myth that the GSEs lost money because of pressure to meet affordable-housing goals, despite the self-serving efforts of some to rewrite history.
Unfortunately, the reality is that Fannie and Freddie still have not brought to low- and moderate-income homebuyers the benefits of a government-sponsored secondary market for affordable rental housing and responsible mortgages.
Having helped to develop innovations that transformed the plain-vanilla student loan into a credit program enriched with borrower benefits, Sallie Mae got help from visionary leaders in the administration and bipartisan leadership in the House and Senate. Together, they charted a careful course away from government sponsorship of Sallie Mae that safeguarded the student loan market, reduced the risk to taxpayers and the federal government and protected their bondholders.
As enacted, the law restructuring Sallie Mae also benefited the District of Columbia through Sallie Mae's payment of an "exit fee" intended as partial compensation for its GSE exemption from payment of local taxes. The law provided for creation of a Delaware-chartered holding company to wind up the GSE, transfer its employees to the holding company, and spin off company assets as long as this did not impair the GSE's condition. Here are some of the "great road truths" from the journey.
• The sky won't fall — if the feds don't lower the boom too soon.
The transition period to financing without the advantage of a government-sponsored cost of funds has to be both limited and realistic. Sallie Mae requested an orderly transition period of at least 10 years before its GSE charter expired; the law permitted nine years, and the company was able to terminate its GSE charter even sooner.
Spinning off GSE assets (for example, Fannie's businesses of automated underwriting, issuing mortgage-backed securities and college housing finance) can help reduce the cost to the taxpayers of the conservatorships and restructuring. The focus during the transition should be on unmet credit needs, such as liquidity for loans on affordable rental housing.
• A "lender of last resort" is an important insurance policy for market stability after the sunset.
Nobody would have predicted the market turmoil of the past two years, but all stakeholders in 1996 were conscious of the need to protect access to student loans, and the overhaul law specified a lender of last resort. This greatly facilitated the federal government's initiative in 2009 to correct for market failures by investing directly in securities of panicked financial markets.
• The government should share in any upside from restructuring Fannie and Freddie and sunsetting the GSE charters.
During its transition Sallie Mae's road map included strict restrictions on activities, including limits on the continued use of GSE borrowing.
Sallie Mae also gave the District of Columbia stock warrants worth 1% of the company's share value on the day before the law's enactment, plus a payment to the Treasury for use of the "Sallie Mae" name. Given the costs of the Fannie and Freddie conservatorships, reimbursing the Treasury will undoubtedly be the priority.
Nonetheless, after decades of not paying taxes to the District of Columbia, the GSEs' restructuring should contemplate what a beautiful high school the Fannie Mae campus on upper Wisconsin Avenue would make!
