This Time Probably Isn’t Different for Fannie, Freddie

Despite recent moves from Congress and the Trump administration, housing-finance reform remains a long way off

By Aaron Back

Shares of housing-finance companies Fannie and Freddie have more than doubled this year on speculation that a resolution on their futures could be near.
Shares of housing-finance companies Fannie and Freddie have more than doubled this year on speculation that a resolution on their futures could be near. Photo: David Zalubowski/Associated Press 

Shares of housing-finance giants Fannie Mae FNMA -5.08%▲ and Freddie Mac FMCC -3.93%▲ have rallied this year on expectations they could soon be released from government control. The exuberance is premature.

Nearly everyone agrees that the current system needs reform so that the two companies, which promote housing-market liquidity by purchasing and securitizing mortgages, don’t remain wards of the state indefinitely. But there are essentially two schools of thought on how to do this. Shareholders want to see them recapitalized and released from government control as soon as possible—something that could be accomplished by the Trump administration alone without congressional legislation. Advocates say the companies could be set up with enough capital and strictly regulated so that they never again pose a threat to the nation’s financial stability.

Currently, the shares are essentially worthless. They could become worth a lot, though, if the government were to end the current arrangement of directing virtually all of the companies’ profits to the Treasury, restructuring them into private, profit-seeking enterprises. Hence the shares trade as highly volatile bets on this eventual outcome.

Critics of such an approach, including many market-oriented conservatives, say it risks leaving an implicit taxpayer backstop in place for the companies should they run into trouble again. They favor a more comprehensive solution that would require new laws. Most “comprehensive” proposals envision an explicit federal guarantee on some mortgage securities and new private competitors to Fannie and Freddie.

The wrangling continued last week. Idaho Republican Senator Mike Crapo released the outline of a legislative proposal that coheres with the “comprehensive” approach and held hearings with sympathetic experts. Several similar proposals have gone nowhere in Congress, though, and it is unclear why this one should fare any better—especially with a divided Congress and a contentious election coming in 2020.

President Trump, meanwhile, signed a directive last week instructing the Treasury and Housing and Urban Development departments to come up with a plan to release the companies. The White House memo included laudable goals such as preserving the 30-year fixed-rate mortgage and making sure taxpayers are compensated for any explicit or implicit bailout guarantees, but it was vague about how these ends would be achieved.

Crucially, the memo said the administration will differentiate between reforms that require legislation and those that don’t, setting a timetable for “administrative” reforms. This could be read as a signal that the White House is ready to proceed in a piecemeal fashion, going ahead alone where it can. But it is unclear how this would work.

Congress still has cards to play as Mark Calabria, President Trump’s nominee to head the Federal Housing Finance Agency, awaits Senate confirmation. At a private meeting in January, acting FHFA head Joseph Otting strongly suggested the administration was ready to go it alone on reform. The White House walked back his comments after a backlash from angry lawmakers.

Moreover, it is doubtful that the administration has enough time to formulate a plan and put it in place before election season kicks into high gear, making it risky to touch an issue as sensitive as housing. Most likely, they could only set the stage to take decisive action in 2021 should Trump be re-elected.

Should a Democrat prevail in 2020, it would be back to square one. Indeed, one substantial downside of a White House-only reform effort is that it would be more easily reversed by future presidents.

Shares of Fannie and Freddie have more than doubled since the start of the year on speculation that a resolution could be at hand. But zooming out, they have essentially been stuck in a range for more than five years, fluctuating up and down with the debate in Washington. This will likely remain the case for a while yet.

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