Fannie and Freddie 2.0: The Senate Does Not Get the Government Out of the Real Estate Market
Given that close to 100 percent of the U.S. mortgage market is now backed by the federal government, it is good that the Senate Banking Committee wants to improve it.
- However, the approach would ensure that U.S. mortgage markets are slightly remodeled rather than completely reformed.
- The government would be at least as involved in these markets as it was prior to the 2008 crash.
The Pre-Crisis GSE System
Prior to the 2008 crisis, Fannie Mae and Freddie Mac were referred to as government-sponsored enterprises (GSEs) because they were quasi-private corporations.
- Though they had the implicit backing of the federal government, they also had private shareholders who stood to lose the capital they had invested in the companies.
- The GSEs purchased mortgages from banks and then packaged them into mortgage-backed securities (MBS).
The GSEs then provided guarantees of principal and interest payments on these MBS, and markets generally assumed that taxpayers would pick up the tab if the GSEs got into trouble.
- If only a handful of mortgages backing a Fannie Mae MBS defaulted, Fannie covered investors’ losses out of its own profits.
- On mortgages that had down payments of at least 20 percent, Fannie covered all the losses. For those home loans with less than a 20 percent down payment, however, the GSEs required private mortgage insurance (PMI).
- PMI companies, in turn, were typically private insurance companies.
The 2008 crisis was far from normal, and it proved that the “implied” taxpayer backing was real.
- The crash also proved that the private capital held in the GSEs was too low to cover those losses.
- Additionally, many PMI companies had too little capital to cover their losses.
Post Crisis and the Senate’s GSE Reform Approach
The problem with the new approach in the Senate is that it would barely change the public–private nature of the pre-crisis GSE system.
Though there are several roadblocks, even in a crisis, to using taxpayer funds to cover MBS losses, the rules make clear that the federal government will pick up 90 percent of losses if there is a crisis.This arrangement is only nominally different from the old system.
The GSEs capital requirements were watered down over the years in the name of expanding their “affordable housing mission.”
- There is absolutely no reason to think that the same thing would not happen again if this approach is adopted.
- At best, the approach would create a series of smaller quasi-private GSEs with higher capital requirements but with the explicit understanding that any catastrophic losses would be covered by taxpayers.
- The approach goes much further by creating a new government agency and an intricate new regulatory framework.
What Congress Should Do
- Reject the approach being offered in the Senate bills.
- These bills would provide explicit taxpayer guarantees that are not necessary.
- Avoid establishing yet another federal regulator in U.S. financial markets.
- Adopt a policy that gets the federal government out of the U.S. housing finance market.
John L. Ligon is Senior Policy Analyst and Research Manager in the Center for Data Analysis and Norbert J. Michel, PhD, is a Research Fellow in Financial Regulations in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.
- Fannie, Freddie Say Overhaul Would Boost Mortgage Rates (online.wsj.com)
- White House, CBO split on Fannie, Freddie (stltoday.com)
- The Son Of Fannie And Freddie (lonelyconservative.com)