Take Fannie and Freddie off the road
By John Gapper
Published: January 26 2011 21:57
What does a failed mortgage giant have to do to get some attention these days? Fannie Mae and Freddie Mac have cost the US taxpayer $150bn and the bill could rise to at least twice that. Yet reform was not included in the Dodd-Frank bill and was ignored by Barack Obama in his State of the Union address.
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It would have been awkward to admit, amid the president’s praise for free enterprise, that his government is much more entangled in its housing market than any European counterpart. Nor is there much sign, even if Fannie and Freddie are wound down, of an appetite for taking away official backing entirely.
It would have been awkward to admit, amid the president’s praise for free enterprise, that his government is much more entangled in its housing market than any European counterpart. Nor is there much sign, even if Fannie and Freddie are wound down, of an appetite for taking away official backing entirely.
Even Republicans who dislike Fannie and Freddie talk of a careful transition and of not damaging the housing market. Investors such as Bill Gross, co-founder of Pimco, have scared them into believing that, as he wrote: “Having grown accustomed to a market aided and abetted by Uncle Sam, the habit cannot be broken by going cold turkey.”
Far from cold turkey, the market is likely to be offered another drug. The Treasury’s long-awaited reform plan will probably permit Fannie and Freddie another five to seven years of life and suggest that the country needs to keep backing mortgage securities indefinitely.
Such timidity in response to Mr Gross’s dire warnings contrasts oddly with Mr Obama’s vision of the US as a country where “ordinary people dare to dream”.
When it comes to US mortgage finance, the dream of a nation in which the free market rather than government decides will remain just that.
In one sense the consensus on Fannie and Freddie has shifted a long way in a short time. Their lobbying power and the illusion that they were widening home ownership to low-income households (in fact, mortgages supported by Fannie and Freddie mostly go to middle class families) used to mean that they were unconstrained.
Now, the school of thought that says they should merely be cleaned up and told to return to how they used to operate in the 1980s is in the minority. “We are talking about reform because the opinions of the 80 per cent of people in the middle have changed. They realise that the model failed,” says Brian Harris, a senior vice-president at Moody’s.
The simplest response to the disastrous muddle created by the government-sponsored entities, which had tacit (and then actual) government support and cheap funding, yet operated as growth-oriented private sector enterprises, would be to withdraw. After all, banks and private sector lenders operated in other countries without similar government involvement, at least until the 2008 crisis.
Dwight Jaffee of the University of California, Berkeley, argues that the public sector has “crowded out” private enterprise in the US housing market without any notable benefits. The rate of owner-occupancy in the US was 67 per cent in 2009 – identical to the European Union average despite the lack of official guarantees for mortgage securities.
But the Washington consensus is leaning towards a hybrid solution rather than being as capitalist as France. I was struck at a conference in Washington this week by the caution of Randy Neugebauer, a Texas Republican who sits on the House of Representatives Financial Services Committee (and who shouted “baby-killer” during a heated debate on healthcare reform last year).
Mr Neugebauer pointed out that Fannie and Freddie and other official bodies backed 98 per cent of mortgage lending in the US last year, so “we are going to need something to replace these entities.” He called for a five-year phase-out for Fannie and Freddie, predicting a “rocky” period of uncertainty. The likely solution seems to be the eventual replacement of Fannie and Freddie with new institutions, perhaps co-operatively owned by banks, which would securitise mortgages in a similar manner. They would not be “too big to fail” themselves but their mortgage securities would be backed by the US government through a catastrophe insurance-type fund.
This would reassure Mr Gross and sovereign wealth fund investors that the US government wants to keep investing in US mortgage paper. The Treasury, which is in no hurry to nail down a solution, believes that the US requires special treatment because the banking market is fragmented and small banks rely heavily on mortgage securitisation.
It would also play to Mr Obama’s new-found centrism, giving something to Republicans with abolition of the GSEs while pleasing Wall Street and not being too radical for Democrats. Matthew Richardson of New York University says the problem is getting the genie of government support back into the bottle. This would stuff it halfway back.
Given where the US housing market is now (weak and perhaps getting weaker) and where Fannie and Freddie sit within it (squat in the middle) it is easy to see why no one wants to disturb the peace. Any change to housing finance has to be carefully managed.
But shifting government support from institutions to the underlying securities is weak medicine considering all the troubles the US has with housing bubbles. Mr Gross warns of yields on mortgage bonds rising precipitously if support is withdrawn but the European experience suggests that mortgages at reasonable rates are not merely an American exception.
If the president wants another Sputnik moment, when the US wakes up to how the world does things, he should dare to dream of a free market in mortgages.
Copyright The Financial Times Limited 2011
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