Commentary

Making a Fannie and Freddie We Could Live With

Fannie Mae and Freddie Mac’s collapse into government conservatorship was a long six and a half years ago. In spite of endless discussions of reform, they remain in conservatorship limbo, where they are run by their regulator as wards of the state, with de minimis capital. Nobody wants the old Fannie and Freddie back; nobody wants them to stay on indefinitely in conservatorship.

What is required are practical steps forward, rather than designing the ideal but politically unachievable solution. We offer Congress the following suggestion as something that can be done now: simply take away all Fannie and Freddie’s special privileges. They could be allowed out of conservatorship when all of the following actions have been taken:

1. Take away Fannie and Freddie’s capital arbitrage and set their equity capital requirements in line with other financial institutions of similar size. Equity of at least 5 percent of total assets should be their required leverage capital ratio. This is the minimum for all big bank holding companies — for Fannie and Freddie it should absolutely not be less. Given their undiversified business, something more might be prudent. In any case, the hyper-leverage which allowed Fannie and Freddie to put the whole financial system at risk needs to be permanently ended.

What is required are practical steps forward, rather than designing the ideal but politically unachievable solution.

2. End all their securities law exemptions. Subject them to the 1933 and 1934 Securities Act requirements like all other companies with public securities. Other provisions of our securities laws that treat Fannie and Freddie securities as the equivalent of government debt should also be repealed.

3. End all their preferences in banking law and regulation. Banks aren’t allowed to hold corporate equity, but as a mistaken exception were allowed to make large equity investments in Fannie and Freddie, on a highly leveraged basis. We know how badly that turned out. For the purposes of all banking regulations, especially capital and asset concentration limits, treat Fannie and Freddie debt and equity securities like any other corporate security.

4. End their exemption from state and local income taxes.

5. Open up their charters to competition just like banking charters. End their exclusive duopoly privileges. Financial history shows that the granting of monopolies and other exclusive privileges come at public expense and often generate considerable corruption. Fannie and Freddie have been no different in this regard. Congress should give chartering authority for additional national mortgage associations to the regulator and allow anyone who can meet the requirements to get a charter and compete. A more competitive market will deliver greater value to the public.

6. End all their exemptions from consumer protection rules. Fannie and Freddie now have a free pass to avoid regulations intended to protect mortgage borrowers — that is ridiculous and continues to promote the perverse outcome that poor quality loans are acceptable if the taxpayer is on the hook.

7. Designate them as the Systemically Important Financial Institutions (SIFIs) they indubitably are. Fannie and Freddie are as big as JPMorgan, Citigroup, and Bank of America and have conclusively demonstrated their ability to generate huge systemic risk. If they are not SIFIs, then no one is; if anybody is a SIFI, then they are. This is simply recognition that all large financials should be treated similarly under the law.

Implementing these steps would go a long way towards making Fannie and Freddie less distortive and far less dangerous, rendering them a Fannie and Freddie we could live with as two competitors among others. Such a de-fanged, de-privileged Fannie and Freddie could safely be brought out of eternal conservatorship. If they again get themselves into insolvency, they could be placed into receivership. In the meantime, debates about the ideal housing finance system can continue.

Mark Calabria is director of financial regulation studies at the Cato Institute; while on the staff of the Senate Banking Committee he helped draft the 2008 act that created the Federal Housing Finance Agency. Pollock is a resident fellow at the American Enterprise Institute; he was president and CEO of the Federal Home Loan Bank of Chicago 1991-2004.