Financial Times: Winding down Fannie and FreddiePosted by on November 21, 2013
It has been five years since Lehman Brothers collapsed and longer since the US subprime bubble burst. Yet plans to reform Fannie Mae and Freddie Mac – the government-sponsored behemoths that underwrite the US housing market – are little nearer to completion. Both Republicans and the Obama administration agree on the need to wind these entities down. Just not quite yet.
Now a group of activist investors are agitating Washington to privatise their key mortgage insurance functions. Last week they raised their equity stakes in the two enterprises. Their business plans no doubt add up nicely – Fannie and Freddie have returned to solid profitability in the past two years. But a sell-off would make little sense from the taxpayer’s point of view. The US has already privatised too many gains and socialised too many losses. It is past time for Washington to start the liquidation of Fannie and Freddie.
The temptation will clearly be to let things drift on for a while longer. Having pumped $187bn into Fannie and Freddie in 2008, the US government has now been more than repaid in dividends and profits. This year alone, dividends from the two GSEs has reduced the US fiscal deficit by almost $100bn. Fannie and Freddie have also helped to underpin the US housing recovery by underwriting roughly two-thirds of new mortgages. Again, the temptation will be to let the apple cart roll on.
Yet the bigger the US government’s exposure to the housing market the more difficult it will be to wind down Fannie and Freddie. Reforming, rather than abolishing, them would be a mistake. Among the plans in circulation is a bill that would replace the GSEs with a smaller agency that would guarantee mortgage lenders against “catastrophic loss” defined as 10 per cent of principal. The Obama administration also wants to continue with the 30-year mortgage loan – a unique feature of the US housing market. Finally, it wants to maintain support for mortgages to low-income borrowers.
The first two goals are unnecessary and risky. There is no reason the US taxpayer should be on the hook for the next housing bubble. If there is a market for mortgage guarantees, then it will emerge. There is no need for Washington to keep inventing one. The Great Depression conditions that led to the agencies’ creation have lost all relevance. Nor should the US government shield borrowers from the effects of monetary policy. No other country allows borrowers to lock in fixed-rate 30-year mortgages and then to refinance their loans when rates fall. Nor should the US. Instead of insuring against risk, it incentivises risk taking. Again, if a market exists for 30-year fixed paper, let it develop. Washington’s role should be confined to regulation.
There is a stronger case for retaining support for low-income home ownership. But Fannie and Freddie are highly imperfect vessels to deliver it. Low-income support should come by targeted and explicit subsidy rather than an implicitly government-backed market. Fannie and Freddie’s 2008 bankruptcy is sufficient testament to how easily others can game the system. By the time the meltdown hit, the two agencies were backing a majority of subprime mortgages. Never again should the US taxpayer have to step in.
Selling the business off to private investors is the worst option of all. Whatever Washington’s protestations, the market would be likely to treat the agencies as implicitly guaranteed. The original design flaws would persist in a new form. Washington should sell off Fannie and Freddie’s assets to the highest bidders. But the core business should be closed down. To avoid disruptions, the process should be gradual and phased. But that is no excuse for waiting. It is time to bring the curtain down on Fannie and Freddie.