Tag: gses

If We Decide to Keep Fannie Mae Around…

I’ve repeatedly said since 2009 that the further in time we get from the crisis, the greater the probability that Fannie Mae and Freddie Mac would survive in some form.  Such looks like an ever-increasing likelihood.  I’m occasionally asked if there are any reforms that would make Fannie & Freddie acceptable.  I’m tempted to say “no.” 

In the spirit of lively debate, I submit the following changes to address most of the flaws in the government sponsored enterprise (GSE) model that would also allow the companies to survive in some form.  I do emphasize that this is not an argument for keeping the GSEs.  That’s a different question altogether.

1)   Open up the charters to competition.  If we learned anything from the rampant corruption that characterized early 1800s U.S. state banking, it is that legislators shouldn’t give out exclusive charters.  Accordingly, the government should delegate chartering authority to the regulator and allow anyone who can meet the requirements to get a charter.

2)   Increase Capital.  Fannie and Freddie were (and still are) massively leveraged.  Laurie Goodman suggests 4 to 5 percent would be a reasonable minimum capital.  I believe something closer to what insurance companies have–around 8 percent (real, not risk-weighted) would be appropriate.  While I’m not completely in the Admati camp on capital, I do agree with her general point that capital isn’t “dead” –it would be used for lending.  And since GSEs aren’t providing some form of payment medium like banks, I see little cost to requiring higher capital levels. So I’d say 8 percent, if not more.

3)   Ditch loan limits, go with income.  In order to make sure these entities actually serve middle-class America, rather than be a subsidy to the well-off, we should eliminate the loan limits and make mortgage eligibility based on income.  This is similar to the USDA’s Rural Housing Service loans.

4)   Break ‘em up.  This might be the most controversial, but simply allowing other institutions to enter the market is unlikely to guarantee sufficient competition.  We broke up Ma Bell.  Under any antitrust standard, Fannie and Freddie are a duopoly.  Unless we are repealing the Sherman Act, the two companies should be broken into at least 6 pieces each and barred from merging.  Existing shareholders would get shares in the off-spring companies.

5)   Require More Mortgage Insurance.  In order to protect the taxpayer, mortgage insurance companies should take the first 35 percent of loss, instead of the customary 20 percent.

6)   Improve Underwriting Standards.  End the housing goals and require minimum down payments of 5 percent and minimum FICO scores of 700.

7)   End all securities law exemptions.  Subject companies to 1933 & 1934 Act requirements. 

8)   End banking law preferences.  Banks aren’t allowed to hold corporate equity, except for that of GSEs.  We know how that turned out.  For the purposes of all banking regulation, especially capital and asset concentration limits, treat GSE securities as you would any other corporate security.

9)   Limit portfolios.  Allow portfolios to be used for an inventory function only. A minimum of 90 percent of debt issued should be required to be mortgage-backed securities (MBS).

These are just some initial thoughts.  Implementing all of these would go a long way towards bringing competition to our mortgage markets and protecting the taxpayer.  If some remain concerned that this lacks a “catastrophic” backstop, then we can allow the Federal Home Loan Banks to discount advances on the MBS issued by these new and improved GSEs.

Geithner Favors Fannie Mae Debtholders over Taxpayers … Again

You have to give Treasury Secretary Tim Geithner some credit for spin: today the Treasury announced “Further Steps to Expedite Wind Down of Fannie Mae and Freddie Mac.” The only problem is that the steps announced largely put the taxpayer at greater risk in order to protect holders of Fannie and Freddie debt.

Essentially, the Treasury has amended its agreements with Fannie and Freddie so that the companies no longer have to pay a fixed dividend to the U.S. taxpayer, but instead “every dollar of profit” from the companies to the taxpayer. The problem is that the Government Sponsored Enterprises (GSE) have never had a year where their profits would have covered the dividend payments, so while we can debate if the taxpayer will recover anything from the GSEs, shifting to just collecting profits definitely means the taxpayer’s potential recoupment is lower.

The GSE’s regulator, the Federal Housing Finance Agency (FHFA) was at least a little more honest in its announcement of the changes, stating that, “as Fannie Mae and Freddie Mac shrink, the continued payment of a fixed dividend could have called into question the adequacy of the financial commitment contained in the PSPAs.”  Read “financial commitment” to mean protecting debtholders from loss.

How does the change protect debtholders over taxpayers? It reduces the ability of FHFA to place Fannie or Freddie into a receivership, under which FHFA could impose losses on creditors. Under Section 1145 of the Housing and Economic Recovery Act, FHFA has the discretion of appointing a receiver if one the GSEs displays an “inability to meet obligations,” which would include dividend payments. By essentially taking away that lever from FHFA, Treasury has greatly reduced any chance of a receivership. Sadly, I believe a receivership was the only thing that would force Congress to also deal with Fannie and Freddie. Treasury’s actions have been a massive win for the broken status quo.

Don’t let the rest of the Treasury announcement fool you. Yes, Treasury has both agreed to reduce the GSEs’ portfolios and to require the GSEs to submit an “annual taxpayer protection plan,” but both of these efforts are little more than fig-leafs to cover Treasury’s protection of GSE creditors at the expense of taxpayers. After all, the first commandment in the Geithner bible, as witnessed during the 2008 bailouts, is that debtholders shall take no losses, regardless of the expense to the taxpayer.

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.

Administration Punts on Reform of Fannie and Freddie

Remember that “tough study” promised by Senator Chris Dodd to deal with Fannie Mae and Freddie Mac?  Well it is finally out.  All 22 pages (of doubled-spaced large font).  And less than half those pages actually discuss Fannie and Freddie.

While the report does say a lot of the right things — such as protecting the taxpayer — it is awfully short on any real details.  And in many areas, the report makes clear that the Obama administration intends to keep the taxpayer on the hook for future losses arising from Fannie and Freddie.  For instance, after assuring us that the GSEs will have sufficient capital to meet their obligations, including debt, the report tells us that such capital will not come from investors, but from the taxpayer.  One has to wonder whether this report was written for the benefit of the Chinese Central Bank (one of the largest GSE debtholders) or for the benefit of the U.S. taxpayer.

Equally vague is the discussion of “winding down” Fannie and Freddie.  While that sounds great, how is this to be accomplished? And how long will it take?  Again it seems that this “wind-down” will be financed by the taxpayer.  It is suggested that the GSE guarantee fees will increase.  Again, by how much and when?

Paragraph 2 of Section 1074 of the Dodd-Frank act, which required this study, also requires an “analysis” of various options and impacts.  In all due respect to HUD and Treasury and their efforts, there is nothing in this report that remotely resembles an “analysis” — just vague generalities.

I appreciate the administration’s stated desire to move us closer to a private market solution, but we’ve heard these empty promises before.  Remember that financial reform was going to end “too big to fail” and bailouts?  Health care reform was going to “bend the cost curve”?  It is past the time of fluff.   We need actual details and an actual plan.  

For details of immediate action that can be taken, see my testimony from earlier this week.