Tag: fannie mae

What’s a Conservatorship Good For?

A central reason that Fannie Mae and Freddie Mac have not played a bigger role in rescuing homeowners, or otherwise handing out “freebies,” is that these two companies are in conservatorship.

Conservatorship is almost like a bankruptcy proceeding, or a receivership in the banking context, but without the power to impose losses. I’ve been criticized for believing that a conservatorship requires Fannie’s regulator to “conserve” the company, and not simply allow it to be used as a slush fund. The basis of said criticism is that FHFA, Fannie’s regulator, has a broad public mission, which could include handing out freebies to underwater borrowers.

Matt Yglesias suggests that “clearly the purpose of creating the FHFA and taking Fannie and Freddie into conservatorship can’t have been to minimize direct taxpayer financial losses on agency debt.” Now, Matt makes a lot of Congress being vague in the statute. And he is correct about it being vague, in some areas, but it isn’t here.

As one of the two people (the other being Peggy Kuhn) who actually drafted that section of the Housing and Economic Recovery Act (HERA) during my time as staff on the Senate Banking Committee, I can clearly say the purpose of the drafters, in terms of conservatorship, was to nurse those companies back to health. Again, how do I know that? Because I was there.

Of course, if one simply read that section of the statute, Section 1145 of HERA, which amends Section 1367 of the 1992 GSE Act, one would clearly see what the purpose, duties, and role of a conservatorship actually is. For instance, what does the law say the powers of a conservatorship are? They are to ”take such action as may be—(i) necessary to put the regulated entity in a sound and solvent condition; and (ii) appropriate to carry on the business of the regulated entity and preserve and conserve the assets and property of the regulated entity.”

Now, I don’t see anything in there about handing out freebies to underwater borrowers. Citing an agency-written mission statement or a vague “purposes” at the beginning of an act is no substitute for actually reading the provisions of a statute.

End the Mortgage Interest Deduction

The mortgage interest income tax deduction is popular among homeowners (read: likely voters) despite its role in distorting housing and related markets, its contribution to the housing bubble and its enabling of additional household debt. Never mind that there isn’t much evidence that the deduction boosts home ownership in the United States. Consider also that the tax break largely benefits affluent homeowners living in expensive urban areas.

As Mark Calabria notes in today’s Cato Daily Podcast, it’s well past time for the mortgage interest deduction to be replaced by lower marginal tax rates for all earners.

No Hope or Change When it Comes to Fannie Mae

The Washington Post is reporting that President Obama has assigned his staff with the task of designing a new set of government guarantees behind the U.S. mortgage market. Although as the Post also reports the “approach could even preserve Fannie Mae and Freddie Mac.” That’s correct. Despite their role in driving the housing bubble and the already $160 billion in taxpayer losses, President Obama appears to be considering just putting the same failed system in place. Of course, we’ll be promised that it will all work better this time.

Perhaps most offensive is that the Post reports that Obama “officials don’t want to punish the thousands of Fannie and Freddie employees who have specialized knowledge about the mortgage market.” Seriously? What about the many blameless employees of AIG, Lehman Brothers, or Bear Stearns? Or New Century for that matter. Did the janitors and receptionists at those firms really cause the crisis? The truth is that the employees of Fannie and Freddie have been lining their pockets at the expense of the taxpayer for years. What the Administration is really saying is that they wouldn’t want all the political operatives at these favored firms to lose their perks. After all, Obama officials will need somewhere to land after 2012 and Goldman Sachs has only so many slots.

What’s most depressing is that you can’t say Obama hasn’t been given the facts. As the Post makes clear, his economic advisers spelled out the case against massive subsidies for the mortgage market. Austan Goolsbee, chair of Obama’s Council of Economic Advisers, points out: by subsidizing mortgage investments, the government drives capital away from other types of investments. If Obama truly wants to help the middle and working class, then he’d want capital to flow into investments that increase labor productivity, which is the ultimate source of wage growth.  Running up asset prices, like houses, does not make us wealthier in the long run.

But then what should I expect. The President has already entered campaign mode. It would be nice to see the economics win over the politics. But it looks like such a thing will have to wait for another administration.

The CAP-AEI Fannie Mae Food Fight

It’s probably never wise to inject oneself into the middle of a food fight, but since I think both sides actually have something right and something wrong, its been a worthwhile debate to follow.  That is the ongoing debate between Peter Wallison at the American Enterprise Institute and David Min at the Center for American Progress (at least we can all agree we love America) on the role of Fannie Mae (and Freddie Mac) in the financial crisis.  If you can’t guess, Peter says Fannie/Freddie caused the crisis, David says they didn’t.

David makes an interesting point, one I’ve actually argued, in his latest retort.  That is, this wasn’t exclusively a housing crisis/bubble.  Other sectors, like commercial real estate, boomed and then went bust; other countries, with different housing policies, also had bubbles.  True from what I can tell.  I will also add that the U.S. office market actually peaked and fell before the housing market, so we can safely say there wasn’t contagion from housing to other parts of the real estate market. 

But the problem with this argument, at least for David, is that it undercuts the Dodd-Frank Act, which he has regularly defended.  The implicit premise of Dodd-Frank is that predatory mortgage lending caused the crisis, so now we need Elizabeth Warren to save us from evil lenders.  But how does predatory lending explain the office market bubble?  Do we really believe that deals between sophisticated parties, poured over by lawyers, were driven by predatory lending practices?  Do we also believe that other countries were also plagued by bad mortgage brokers?  Again, I think David is right about the problem being beyond housing, but he can’t have it both ways.

What is the common factor driving bubbles in commercial real estate, housing, and foreign real estate markets?  Maybe interest rates.  This was a credit bubble after all.  Especially since the Fed basically sets interest rate policy for the world.  It is hard for me to believe that three years (2002–2004) of a negative real federal funds rate isn’t going to end badly.  This is what I think Peter misses, the critical role of the Federal Reserve in helping blow the bubble.  But Dodd-Frank does nothing to change this. 

Now there are a ton of things I think both still miss.  We could argue all day about what a subprime mortgage is.  I think the definitions used by Wallison (and Pinto) are reasonable.  There is also a degree, a large one, to which David and Peter are just talking past each other.  For instance, there is something special about the U.S. housing market that transfers much of the risk to the taxpayer.  In contrast, the bust in the office market didn’t leave the taxpayer to pick up the tab.  That has to count for something, unless one just doesn’t care about the taxpayer. 

There are a few other issues that make Fannie/Freddie uniquely important in the crisis, but I lack the space to go into them here. Instead, I’ll wrap up by saying that their role in the overnight repurchase (re-po) market is under-appreciated and their ability to essentially neuter the Fed was critical in keeping the bubble going.  What’s for dessert?

Exit Interview with Sheila Bair

Sunday’s New York Times Magazine has an interesting exit interview with Sheila Bair, who until this past Friday served as Chair of Federal Deposit Insurance Commission (FDIC). While I haven’t always been her biggest fan, I did find it refreshing to hear a bank regulator state the obvious:  we should have let Bear Stearns fail. As she puts it:

Bear Stearns was a second-tier investment bank, with — what? — around $400 billion in assets? I’m a traditionalist. Banks and bank-holding companies are in the safety net. That’s why they have deposit insurance. Investment banks take higher risks, and they are supposed to be outside the safety net. If they make enough mistakes, they are supposed to fail.

I’d be hard-pressed to say it better. Assisting the sale of Bear to JP Morgan created the expectation that anyone larger, like Lehman, would be assisted as well. Perhaps the most interesting part of the interview is that Bair gets right to the heart of the matter: the treatment of bondholders. ”Why did we do the bailouts?” Bair states “It was all about the bondholders.” Again she couldn’t be more correct. If there was anything Dodd-Frank should have fixed it was this, ending the rescue of bondholders and injecting market discipline back into bank.  It is also refreshing to hear her admit: ”I don’t think regulators can adequately regulate these big banks, we need market discipline. And if we don’t have that, they’re going to get us in trouble again.”

Where I disagree, besides her misguided take on mortgage re-sets, is whether Dodd-Frank will actually impose losses on bondholders. Bair expresses some optimism that such is the case, but there are just too many holes in Dodd-Frank to make that believable. Plus you pretty much have the same set of rules in place for Fannie Mae and Freddie Mac, yet the last time I checked the bondholders are still being protected at the expense of the taxpayer. If we don’t impose losses on Fannie creditors, even now after the panic, what makes anyone think we will do so to Citibank. Section 204 of Dodd-Frank is quite clear that the FDIC indeed retains the power to rescue creditors. Something that Bair was willing to do during the crisis, even if pushed to do so by Tim Geithner. Despite some errors, the interview is really a worthwhile read and has some real lessons for avoiding the next financial crisis.

Monday Links

  • Regulatory privilege is not consistent with competitive markets–that’s why Fannie Mae and Freddie Mac need reform.
  • Thank goodness the U.S. Supreme Court found that education tax credits are not consistent with the fictitious notion of a “tax expenditure.”
  • President Obama’s budget plan is not consistent with either his own deficit commission’s plan or the Constitution.
  • The modern “Executive State” is not consistent with Article II of the Constitution.
  • Cyberbullying laws are not consistent with the First Amendment and our concept of free speech:

Fannie, Freddie: Late to the Party?

Debates over the causes of the financial crisis sometimes center on whether Fannie Mae and Freddie Mac were “late to the party” in terms of subprime lending.  As it relates to the recent crisis, I address this question elsewhere

The GSEs and their apologists do claim to have been big contributors to one party: the expansion of homeownership in the United States.  Yet the facts suggest otherwise.

The chart below compares the GSE’s market-share, in terms of home mortgage lending (as reported in the Fed’s Flow of Funds data), with the national homeownership rate (as reported in the Decennial Census). 

The chart makes readily apparent that the largest increases in homeownership occurred before the GSEs played much of a role, if any, in the mortgage market.  For instance, by 1970, the homeownership rate had reached 62.3, yet the GSE market-share was just above 6%.  Even a decade after Fannie was “privatized,” the GSE market-share was still under 20%.

The real growth in GSE activity occurred during the 1980s, particularly the later half.  The reason?  The implosion of the savings and loan industry.  It seems we simply substituted several thousand mismanaged and under-capitalized thrifts for two large mismanaged and under-capitalized thrifts.  Interestingly enough, as the GSEs were doubling their market-share in the 1980s the homeownership rate actually fell.  By the time the GSEs had reached a market-share of 50%, the U.S. homeownership rate had already come close to the rate we see today, of 66%.

The data clearly show that we became a nation of homeowners with little assistance from Fannie and Freddie.  Not only did they join that party late, they simply took the place of the last group to ruin the party:  the S&Ls.