Return of the Housing Monsters
Private profit but taxpayer risk, with Fannie Mae and Freddie Mac. What could go wrong?
By The Editorial Board
Photo: Cfoto/Zuma PressAmerica in the 21st century sometimes seems destined to repeat all of the mistakes of the 20th.
The latest is President Trump’s desire to release Fannie Mae and Freddie Mac from government captivity—along with a government guarantee.
Didn’t we learn this was a bad idea the first time?
The President teased on social media recently that “I am working on TAKING THESE AMAZING COMPANIES PUBLIC,” referring to Fannie and Freddie.
“I want to be clear, the U.S. Government will keep its implicit GUARANTEES, and I will stay strong in my position on overseeing them as President.”
Their share prices surged.
Investors are elated that Mr. Trump plans to re-privatize these firms—especially because he has now made their government backstop explicit.
The President may think the feds can keep the housing monsters on a regulatory leash, but the political and financial incentives mean they will invariably revert to their reckless ways.
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During the housing bubble in the 2000s, Fannie and Freddie used their implicit government backstop to borrow at low rates to buy and securitize risky mortgages.
No proof of borrower income?
No problem.
When housing prices dropped, subprime borrowers sank underwater.
Delinquencies and losses rose.
The mortgage giants needed a government bailout.
We argued that the monsters should be put into receivership so they couldn’t rise again.
But Treasury Secretary Hank Paulson placed them in government conservatorship.
In return for a $190 billion capital infusion and $200 billion line of credit, Treasury received senior preferred shares in the companies that entitled the government to dividends as well as warrants to buy up to 79.9% of their common stock.
The government life-support was crucial as the un-dynamic duo lost a combined $265 billion between January 2008 and March 2012.
Their losses would have been larger if not for the Federal Reserve’s mortgage-backed securities purchases.
The Obama Administration also stanched their losses with rules making it difficult to foreclose on delinquent borrowers.
The Federal Housing Finance Agency (FHFA), the regulator that now oversees the duo, contained them for a while.
But over time they have been allowed to ease underwriting standards and expand the mortgages they guarantee, including vacation homes.
In 2019 the Trump Administration let them retain profits, rather than remit them to Treasury, so they could build a capital cushion for an eventual release.
Ballooning home prices plus a tsunami of sales and refinancing in the pandemic boosted their guarantee fee income.
This has let Fan and Fred accumulate some $160 billion.
That’s still about $320 billion short of FHFA’s capital requirements, which are more lax than the Fed’s for big banks.
Delinquencies are low in a growing economy.
Fannie and Freddie have also encouraged mortgage servicers to waive and reduce monthly payments for delinquent borrowers, reducing defaults.
Fannie and Freddie back $7.7 trillion in loans and account for half of the single-family mortgage market.
Loans they’ve guaranteed in recent years have become increasingly risky, though at least the Biden FHFA last year nixed a Freddie plan to guarantee second mortgages, which are effectively consumer loans.
Yet hedge funds that own common shares in Fan and Fred are pressuring the Trump Administration to release them, and you can see why.
Their profits will be private but the risks will be socialized on taxpayers.
FHFA Director Bill Pulte has floated letting the firms have public stock offerings and use them “for what they are, which are assets for the American people.”
That sounds ominous.
Is the idea for the government to keep its preferred shares (currently valued at $355 billion) while using the dividends to finance Mr. Trump’s mooted sovereign wealth fund or strategic crypto reserve?
Such a plan could spur regulators to ease up on the firms so they can mint bigger profits for the government even while increasing the risk for taxpayers.
Bill Ackman, whose Pershing Square Capital manages funds that own shares in Fannie and Freddie, has pitched a plan that involves the government taking the two firms public, canceling its preferred shares, and easing their capital requirements.
This would be a $355 billion gift to current shareholders and increase the risk of a future bailout.
The American Enterprise Institute’s Ed Pinto sensibly argues the GSEs should be shrunk and well-capitalized before a release.
They should also pay the government a fee for their implicit guarantee that would account for their mortgage risk and the U.S. government’s higher borrowing costs because Fannie and Freddie securities compete with Treasurys as “safe” assets.
Mr. Pinto estimates such a fee would cost Fan and Fred $46 billion a year.
To mint dividends for investors, they’d have to raise their guarantee fees, which would lift mortgage rates.
Trump officials insist they won’t release the godzillas if doing so would raise costs for homebuyers.
***
In a better Washington, Congress would shrink Fan and Fred and encourage more private competitors.
But the worst of all worlds would be to unchain the monsters in a way that would give the government and private investors a mutual incentive to expand risk at taxpayer expense.
Americans have seen this horror movie before, and it didn’t end well.
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