What Do We Do with Fannie and Freddie? The Politics of Change

What Do We Do with Fannie and Freddie? 

Housing, Housing Policy, Housing Authority

The Treasury Department and the White House held the first major conference devoted entirely to housing finance last month. While tougher origination standards are still within earshot of the House Financial Services Committee, the core topic of the conference was what to do with Fannie and Freddie (the GSEs). With the financial overhaul behind congress, the push is on to find a political and economic consensus. Until now, the administration’s view has been that the GSEs should be scaled down as intermediaries which serve the “underserved” and should otherwise abandon their portfolio activities. However, it is uncertain at the outcome of this conference whether or the White House will take the middle road to addressing the issue.

The political dynamic of the problem takes three dimensions. First, the lobbying at the local, state and federal level by the allied housing industries is significant. As an example, in just the first two quarters of 2010, over 782 individual lobbying reports were filled with the Office of the Clerk of the U.S. House of Representatives. This represents just over a half a billion dollars in lobbying expenditures devoted entirely to housing. Second, the Democrats have generally voiced their supported for keep the GSEs as a backstop for providing conduit securities activities for middle income mortgages for the cross-section of the country. This in a sense would return the GSE’s to the original rationale for the creation of Fannie Mae. However, some fiscally conservative democrats have cited the argument long made at the Federal Reserve that the premium associated with an implied government backing has not translated into across the board lower rates, as this premium has been largely manipulated to the benefit of Fannie Mae’s portfolio and stock holders. For just this reason, there is a growing bipartisan consensus for scrapping all of Fannie Mae’s portfolio activities. The minority of critics who challenge this ideaargue that systematic risk is almost unavoidable and that the GSE’s hedging activity actually reduced market volatility.

The third political prong is associated with the Republican and libertarian position that the GSE’s should be entirely scrapped. The foundation of this argument is two fold. First, they argue that GSE’s are inherently unable to mitigate the moral hazard risk by virtue of their chartered ownership structure. Second, they argue that risk is not appropriately priced in the market due the implied backing of the government. Some economists have extended this price distortion argument to argue that the U.S. offers too many subsidies to housing as it is. Is it possible that our homes are even more overvalued relative to what we thought had already been undervalued?

For this reason, if only for the rhetorical impact, the politics of winding down the GSE’s may ultimately rest on the immediate financial impact that constituents would feel if the GSE’s disappeared over night. Perhaps for this reason, the H.R. 4889: GSE Bailout Elimination and Taxpayer Protection Act has only garnered 21 sponsors in the house — just a fraction of the total Republican support expected. As it stands, the U.S. government controls 95% of all mortgages either through FHA insurance or GSE loan purchases. This begs the question: would elimination of GSE market activity all together freeze the system? One analyst at Barclay’s Capital sees the scenario like this. In the process of privatizing, the delinquent portfolio is pushed to the forefront where it is grossly undervalued by the market. Likewise, because of the guarantees associated with these delinquent pools, the government would just be giving away money even if they sold at a relatively steep discount to UPB. In fact, it would be so undervalued that it would take a Resolution Trust type entity to manage the assets. At this point, you are just recreating an organization that already exists within the GSEs. The analyst goes on to argue that without the government guaranteeing mortgage purchase in the secondary market, regulated entities and foreign governments which are mandated by law to purchase investments within a government class of assets would be prohibited from further investment.

This is a worst case scenario in the political near term with mid-term elections coming up this year. So playing it safe by reorganizing the public equity of the firms and by eliminating portfolio “hedge fund” activities may just be the outcome for the GSEs. The conference taking place today at the Treasury Department is made up of a variety of academics, pundits and industry stakeholders. While this high profile event demonstrates a commitment towards innovative solutions by the White House, it is unlikely that anything substantive beyond the aforementioned will emerge as a guiding point for the administration. It is quite possible that the administration has made up its mind and that it is simply paying lip service to the far left who wants to revamp GSE as another CRA vehicle and to the far right who can’t be left out of the picture because they know their populist libertarian rhetoric strikes a chord with voters in key states this fall.

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