Fannie and Freddie: Two Where One Will Do
While Fannie Mae should have a smooth transition to a new system, Freddie Mac might find the path more treacherous.
Calls from various constituencies in the business to establish a single mortgage-backed security are sensible. But why stop there?
Months ago, the Wall Street Journal's John Carney suggested that if Congress was not going to eliminate Fannie Mae and Freddie Mac, it should consider merging the two into a single entity. The Senate was still debating Johnson-Crapo reform legislation at the time and the merger suggestion got no traction.
That is too bad, because the idea of combining the government-sponsored entities should be seriously entertained. Unlike other reform proposals, a merger would not require additional legislation. The Federal Housing Finance Agency could unify Fannie and Freddie under its existing receivership authority. Moreover, merging the GSEs would be a logical extension of the current FHFA program that seeks to make the enterprises more efficient by eliminating their duplication of efforts.
History shows that one GSE is enough. Fannie Mae was founded under the New Deal and existed for three decades before Freddie Mac was created to have parallel authority to provide a secondary market for conventional mortgages. In the words of the journalist James Hagerty, the twins grew to dominate the market "not because of any plan but through political expedience, neglect and drift."
In the aftermath of the most recent financial crisis, the GSEs' domination of the secondary market is complete. Until Congress gets around to reforms, the FHFA could at least make them less expensive to run, reducing the threat that they will need more support from the Treasury and perhaps reducing the cost of obtaining a mortgage.
The FHFA now has three proposals under consideration to promote the uniformity of GSE products and procedures. But forcing the two companies to function as one while maintaining two corporate structures is less cost-effective than eliminating duplication by merging them.
The first proposal, which is already being implemented, creates a common platform, i.e. a common back office, to issue mortgage-backed securities for both companies. Fannie and Freddie have already established a new, jointly owned corporate entity to own and operate the new common platform.
The second is a rule proposal that would create a single security for both GSEs a standardized instrument designed to eliminate trading disparities between the mortgage-backed securities of the two companies. Freddie currently provides discounts, including reduced fees, to incentivize investors to buy its securities over Fannie's and "typically must compensate lenders for the disparity," according to the Wall Street Journal. If the GSEs became unprofitable again and Treasury had to step in, it is the taxpayers who would foot the bill to entice investors to acquire Freddie's securities.
A GSE merger would be an even more attractive way to solve this problem, since it would permit the intermingling of mortgages that have already been acquired by one or the other of the GSEs into a single mortgage-backed security. Merging the securities that have already been issued by both companies is not part of the FHFA rule proposal.
The GSEs themselves are behind the third proposal to establish a single set of capital requirements and other criteria for the private mortgage insurance companies that insure loans sold to the GSEs. This joint development of operational standards by the GSEs underscores the ways in which the two companies are already functioning as one.
The reality is that legislation reforming, replacing or dissolving the GSEs remains years away; meanwhile the government conservatorship of Fannie and Freddie will continue. This means that taxpayers are still at risk for losses incurred by the GSEs.
The expense of running two companies is simply unacceptable, given that the regulatory proposals of the FHFA appear to already recognize that a single merged entity is more efficient. Staff compensation, plant maintenance, marketing, legal and compliance functions, advertising and every other duplicative procedure and operation of the two companies represents an opportunity to reduce the costs of providing liquidity to the secondary mortgage market.
The authority of the FHFA under the Housing and Economic Recovery Act is clear. If the conservatorship is brought to an end by its conversion to a receivership, then in the words of the statute: "The Agency may, as receiver for an enterprise, organize a successor enterprise. " The goal of the conservatorship is to conserve the assets of the corporations, and a merger is entirely consistent with that goal.
Congress, in the fullness of time, can still decide to replace or dissolve the GSEs. In the meantime, the taxpayers and all stakeholders of Fannie and Freddie will benefit from reducing the costs of having two where one will do.
Stephen A. Blumenthal is an attorney with Williams & Jensen PLLC in Washington. He served as the deputy director and later as acting director of the Office of Federal Housing Enterprise Oversight, the former regulator of Fannie Mae and Freddie Mac.