Fannie Mae and Freddie Mac are in the news again after President Donald Trump’s administration recently submitted a plan to reform the government-sponsored enterprises, or GSEs. Without releasing too many details, the White House said it wants Fannie and Freddie to become “full private entities” that raise capital in the private market, not on the taxpayer’s dime.
At the peak of the financial crisis, Fannie and Freddie dominated international headlines. It feels like an eternity since former Treasury Secretary Henry Paulson announced that the secondary mortgage lenders would be under the conservatorship of the Federal Housing Finance Agency (FHFA) in the wake of the housing collapse. But here we are, ten years later, and nothing has really improved at the GSEs, which is probably why the Trump administration wants to reform them.
To celebrate their tenth anniversary under state conservatorship, the American Enterprise Institute (AEI), a conservative think tank, held a special event to discuss their past, present, and future. Attended by key individuals like Mike Fratantoni of the Mortgage Bankers Association, Edward J. Pinto of the AEI, and Norbert Michel of The Heritage Foundation, several important questions were put forward that need to be answered amid brewing trouble at the FHFA headquarters.
Is it time that Fannie and Freddie shrink their activities? Are they making it difficult for private lenders to compete against GSEs? Can future private capital combat market distortions created by Fannie and Freddie? Are Fannie and Freddie exploiting these powers?
These are all relevant questions. However, here is an even better question: Is it time to abolish Fannie and Freddie altogether?
A Brief History of Fannie and Freddie
The business model of Fannie Mae and Freddie Mac was questionable from the very beginning. A relic of the New Deal era, it consisted of borrowing at low-interest rates, reinvesting its loans into whole mortgages, and securitizing mortgages for the investment market by offering mortgage-backed securities (MBS). Throughout much of its history, the companies were given guarantees from the government. If they ever got into trouble, taxpayers would bail them out.
Of course, you could maintain the worst business practices possible if you have government support.
Why? Because the government is in the social-engineering racket, and these quasi-private companies wanted to make sure veterans, the impecunious, and every other American had the so-called right to access credit, purchase a home, and live the American Dream. This was even conceded by a former executive.
In 2002, then-CEO of Fannie Mae Franklin Raines declared that he is in the “American Dream business.” Raines stated that his company’s mission is to ensure every American attains the ultimate dream of homeownership. At the time, he also had the temerity to suggest Fannie boosts capital markets and emboldens entrepreneurship.
Six years later, Fannie and Freddie helped destroy the American Dream through market manipulations, lending to people who could not afford property, and implementing foolish policies like low interest rates and zero down payments.
By 2008, Fannie and Freddie owned or guaranteed roughly half of the nation’s $12 trillion mortgage market. Their shaky foundation was held together because nearly everyone owned its bonds, from retirement funds to the Chinese government. If Fannie and Freddie crumbled, there would have been immense short-term pain all over the world.
It has only been in the last couple of years that Fannie and Freddie were able to eliminate the foul residue of delinquent mortgages from their books. They auctioned off non-performing mortgages that were made leading up to the financial crisis, many of which went unpaid for as long as six years. Most of these delinquencies were acquired by Goldman Sachs.
Today, the left and right both say that the government’s absorption of Fannie and Freddie is a positive example of state intervention into the free market. Like the government saving the automakers, the interventionists believe they saved the U.S. from financial ruin. This couldn’t be further from the truth; they merely kicked the can down the road.
Bailing Out Fannie and Freddie Again
So, the bailouts of Fannie and Freddie count as a success story, right?
In February 2018, as part of the White House’s draft budget, the Treasury Department transferred a $5.1 billion bailout to Fannie and Freddie because there was very little money left in their coffers. Since they hold billions of dollars worth of tax-deferred assets on their balance sheets, Congress mandated the organizations to slash their amount of capital and transfer quarterly balances to the Treasury.
That isn’t all.
Fannie and Freddie will be required to receive aid from the Treasury again because of an accounting rules change for loan-loss reserves. As part of the Financial Accounting Standards Board’s Current Expected Credit Loss (CECL), Fannie and Freddie will be given a bailout of $7.5 billion and $5 billion, respectively, to abide by the latest requirements. They have some cash in their capital reserves, but it will not be enough to cover the rules update.
It gets worse.
In recent years, Fannie and Freddie have returned to their 2006 ways. Since 2014, the mortgage agencies have lowered their down payment rate to just 3%, following the Federal Housing Administration (FHA)’s reduction in annual mortgage insurance premiums to 0.85%.
Simply put: Fannie and Freddie have failed to learn from their mistakes. Not only are they resorting to their old practices that helped fuel the collapse, they continue to distort the housing market. Their failings are being masked by a booming housing market; without a dramatic jump in home values, we would collectively call for heads.
Reform or Abolition?
It remains unclear if the federal government will move ahead with the White House’s planned reforms. Ben Carson, Secretary of Housing and Urban Development (HUD), signaled that he endorses further discussion on the proposal, but there hasn’t been anything concrete.
It should be simple enough for even the politicians: If something isn’t working, take an ax to it.
Like the big banks on Wall Street, Fannie and Freddie should have been allowed to fail, not enabled. It may have been a bitter pill to swallow, but it would not have led to greater pain in the future. The policy prescription of perpetual bailouts is not a cure for organizations that maintain the most reckless of business models that turn the American Dream into an American Nightmare.
Unfortunately, as long as we believe that a house and a mortgage are a right, we will continue to experience the booms and the busts, the privatization of the profits, and the socialization of the losses. Fannie and Freddie are just more exhibits of moral hazards brought to you by the big government social engineers in the swamp.
How comes it that in Washington, history always repeats itself?
What do you think should happen with Fannie Mae and Freddie Mac? Let us know in the comments section!