Posted by Dr. Anthony B. Sanders on 18 January, 2011 at 2:49 pm. 15 comments already!


The Obama Administration is releasing its plan on the future of the housing finance industry. More specifically, they are releasing their plan on what to do with the mortgage giants, Fannie Mae and Freddie Mac.

The Obama Administration’s plan for housing finance will likely be short on details and long on government involvement in the housing and mortgage market. Remember, the Obama Administration is wedded to “Big Government” solutions, so any final form of FHA, Fannie and Freddie will likely be a reshuffling of the deck chairs on the Titanic rather than a sensible reconsideration of national housing policy.

The Administration has signaled that it would like an explicit guarantee for residential mortgages rather than the “implicit” guarantee that Fannie Mae and Freddie Mac denied for years. The explicit guarantee will be welcome news to banks, investment banks and investors like Bill Gross at PIMCO. The guarantee is bad news for taxpayers since it signals that will be on the hook for staggering losses in any future housing bubbles/bursts or recessions.

The irony of making the government guarantee explicit (rather than implicit) is that there has always been a spread between Fannie and Freddie debt and comparable-risk commercial banks. This indicates that the guarantee has always been explicit (that is, everyone in the capital markets knew that the Federal government would bail out Fannie and Freddie when the time came). So simply making the guarantee explicit is misguided at best and disingenuous at worst. Even if the Administration or Congress said that there would be no future bailouts of Fannie and Freddie, nothing would prevent Treasury or the Fed from doing it anyway. So, it is really a statement about doing nothing.

We need to have a discussion in Congress about how much “affordable housing” we want in the USA. We simply don’t know the size of the affordable housing mission, since Fannie, Freddie and the FHA are almost purely opaque (that is, has virtually no transparency). This debate will likely never happen, so we will never know how much affordable housing were are subsidizing or at what cost. Of course, if the Federal government wants to have risky affordable housing mandates at taxpayer expense, it would make sense that they fight for little or no transparency. I predict that no steps will be taken towards any meaningful transparency.

The other problem with Fannie and Freddie is that they are essentially off-balance sheet entities (in other words, our own big Greek Islands). If we aren’t going to put them on balance sheet as we do with the FHA, they must be at least transparent so we and the rest of the world knows how much risk they are bearing. It is doubtful that the Obama Administration wants any transparency at all.

Of course, it makes sense to downsize Fannie and Freddie over the next five years so that they will be gone or minimized in the near future. This can be accomplished by reducing the conforming loan limit 1) back to pre-crisis levels and 2) then reducing the limits by $50,000 per year. And their retained portfolios, the source of much of their losses (along with “investments” in subprime ABS), should be sold off and unwound over, say, 5 years.

Eventually, the US has to return to the 20% down payment standard for loans. Households unable to accumulate the 20% down payment and rent their dwelling and save for a down payment. Otherwise, we are doomed to repeat bubbles and bursts in the housing market. Of course, this type of financial discipline is very unpopular with affordable housing groups (except that they don’t bear the risk of declining house prices — the taxpayers bear that risk). We have the FHA for affordable housing programs and we don’t need Fannie and Freddie doing the same thing. Our Federal government actually subsidizes affordable housing groups, so it is likely that they will fight extremely hard to keep low down payment mortgages and Community Reinvestment Act (CRA) programs,

Everything Fannie and Freddie does can be done by the private sector. The only thing Fannie and Freddie have going for it is the 1) government guarantee and 2) lack of transparency. Both should be abolished. Besides, we know the Fed will step in for to provide liquidity. The default insurance should be wholly privatized. The notion that someone at the GSEs or Fed can magically determine the correct risk premium is hilarious; the moral hazard implications of having the Federal government pricing insurance or anything else are legion.

The Fannie/Freddie debate will be the first test of the Republicans will to tackle endless socialization of mortgage risk. Unfortunately, our country is so addicted to government subsidization and control of the housing and residential mortgage market that politicians will have great difficulty imagining a world without Fannie and Freddie. For the preservation of our future, we really need to shut down Fannie and Freddie and let free markets operate again.

See U.S. Representative Darrell Issa’s piece on unaffordable housing here.

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