There have been lots of ideas about how to restructure Fannie Mae and Freddie Mac, the twin government-sponsored enterprises (GSEs) that purchase the vast majority of residential mortgage loans originated in the U.S. But the one idea that I haven’t heard mentioned, which seems to make the most sense, is: Don’t do anything.
The two agencies used to be hybrid public-private entities, their stock owned by investors but with an “implied” government backing of the mortgage-backed securities they sell. Both of them failed during the global financial crisis, burdened with billions of dollars of bad subprime loans, and were taken over by the government in 2008. Although they remain in conservatorship to this day, they remain the backbone of the American residential mortgage banking system.
The government, i.e., taxpayers, spent $188 billion to bail out the two agencies when they failed. Since then, under government protection – and stricter underwriting – they have earned nearly $266 billion, most of which has been returned to the U.S. Treasury. That’s a pretty fair return on a mighty risky investment.
Which is the main reason for believing that the best solution to dealing with them is to leave them as they are, as wards of the government, maybe not in “conservatorship” per se, but something close to it. That way they can’t do a lot of damage under the pretense of being a private company while doing a lot of good. Indeed, the two agencies are indispensable to the American residential real estate finance industry, which many observers have pointed out remains one of the wonders of the global financial services industry. Where else can an individual homeowner get a 30-year fixed rate mortgage at rock-bottom interest rates? It’s due to Fannie and Freddie and their government backing.
The past nine years have shown that having Fannie and Freddie as privately-owned but implicitly government-insured companies was a huge mistake. Investors in the company’s stock, who lost most of their money following the government seizure, had a false sense of security in the meaning of the word “implied,” which has a far different meaning than “legal” or “actual.” Shareholders found out the hard way the difference between the two.
While many people rightly question whether the government should be so heavily involved in the mortgage business, which ideally should be run 100% by the private sector – like credit cards, auto loans and all manner of consumer lending businesses – the fact of the matter is it simply can’t. No one knows this better than the thousands of lenders who originate mortgage loans to consumers and then sell the loans, directly or indirectly, to Fannie or Freddie, enabling them to make even more loans. If they are honest with themselves, lenders and the associations who represent them know they could not last a day without a huge government-insured secondary market backing them up.
While there is certainly a place for the private sector in the secondary market for mortgage loans, it’s only to act as a niche market for loans that are too risky for the government agencies to buy, loans with high loan-to-value ratios or those made to people with low credit scores. Taxpayers – as we saw in 2008 – should not be put at risk in making such loans. But that is the rightful venue for private investors. If they want to make higher-risk loans with their own money, that’s up to them, not taxpayers.
One of the most pressing and legitimate issues involving Fannie and Freddie is that since they’re sending so much of their profits back to the Treasury, they’re in danger of depleting their capital and going bust again, setting up the need for another government rescue. So it seems self-evident that the solution is to simply let them keep the money, or at least a portion of it, to ensure their solvency and to finance their operations.
Investors, investment bankers, legislators, government officials and many other people have been wrestling for nearly the past 10 years about what to do about Fannie and Freddie. One of the questions many of them struggle with is how to get the government less involved and the private sector more involved in the secondary mortgage market. But history and experience have shown us that less government involvement is simply not going to work. Private lenders would revolt, and so would consumers, not to mention politicians.
So it seems there’s a fairly obvious solution to the Fannie-Freddie question: Leave them as they are. For the past nine years, the mortgage market has operated quite nicely under the current arrangement. Credit quality, which brought the two agencies down in 2008, has improved dramatically, as witnessed by how profitable the two are. Fannie and Freddie could become largely self-funded by allowing them to retain a portion of their earnings to guarantee their solvency while returning the rest to taxpayers as a dividend. Imagine that: government agencies that pay for themselves, and then some.
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INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.