Since 2008, we’ve had a zombie mortgage-financing system, a situation that we should no longer tolerate. That year, in the wake of the collapse of the housing market, the government placed Fannie Mae and Freddie Mac, which underwrite the mortgages of many Americans, into conservatorship--a form of nationalization. It was meant to be temporary, but the two government-supported enterprises (GSE's) remain there, stuck.
Congress and the Obama administration have been unable or unwilling to work together to get Fannie and Freddie back on their feet. Remarkably, the former chairman of the Senate Banking Committee, Tim JohnsonTim JohnsonBank lobbyists counting down to Shelby’s exit Former GOP senator endorses Clinton after Orlando shooting Housing groups argue Freddie Mac's loss should spur finance reform MORE (D.-S.D.), urged Mel Watt the head of the Federal Housing Finance Agency, which oversees Fannie and Freddie, to work with Treasury to end conservatorship without Congress. Watt, however, has long said it's up to his former colleagues in the Senate to resolve the issue. After Johnson’s comments, Treasury let it be known that fixing Fannie and Freddie was a job for our elected representatives. So it’s back to gridlock.
Why does it matter that Fannie and Freddie are zombified? Nationalization means American taxpayers are on the hook for every penny of the $6.5 trillion in loans the GSE’s have securitized. And the situation is uncertain, with banks pricing in that uncertainty. They aren't sure which loans Fannie and Freddie will guarantee if borrowers are found to have engaged in fraud, for instance, so potential homeowners who might otherwise qualify for a loan with a 10 percent down payment are being asked for 15 percent. As a result, fewer Americans can afford homes.
Some people have asserted that the law that created conservatorship stipulates that Congress end it, but that's just not so: The law granted FHFA's director the powers essential for "reorganizing, rehabilitating, or winding up the affairs of a regulated agency.” Guiding Fannie and Freddie out of conservatorship surely falls under that power.
Critics also say that without Congressional action Fannie and Freddie can't afford to pay the Treasury back the market value of the "backstop" the federal government has been providing, as it is required to do. Calculating the value of that guarantee could keep an army of accountants busy for years. But since 2012 the Treasury has been sweeping all of Fannie and Freddie's profits into its coffers, a total of nearly $220 billion— more than the original $190 billion cost of the bailout. Letting Fannie and Freddie use those profits to build capital would be a big step in the right direction.
In exchange for providing a backstop on housing loans, the Treasury was granted preferred stock in the entities worth some $200 billion. Its sale would further contribute to the GSE’s capitalization.
What would ensure that a newly independent Fannie and Freddie wouldn't take us right back to where we began— backing unsustainable mortgages? First of all, contrary to popular opinion, during the meltdown Fannie and Freddie held relatively few "subprime" loans. They do not deserve inordinate blame for the crisis. Additionally, the FHFA (Mel Watt’s agency), did not exist when the crisis was brewing. It’s a regulator with teeth.
Finally, quite a few of the most dangerous types of loans—those that required only payment of interest, for example—have been banned by law. The missing ingredient in the return of Fannie and Freddie to the playing field is capital, plain and simple.
It's widely thought that a 5 percent capital-to-debt ratio would be a sufficient cushion to weather a shock of the magnitude that struck a few years ago. It might take three to five years to reach that goal, but the sooner we get started the better.
Some reforms are necessary. A revived Fannie and Freddie should rethink how they deal with loans to low- and mid-income borrowers. Congress has in the past demanded that a substantial fraction of the loans they back be low- and mid-income loans. Rather than explicit targets, I would like to see new “guarantee fees” added to non-low, non-mid loans, which could be used to create an emergency fund for homeowners who hit a rough patch—a job loss or other temporary crisis. Making Federal Housing Administration loans the main instrument targeting low-income homeowners would reduce mission overlap, with Fannie and Freddie’s rainy-day funds serving as a backup.
Neither Democrats nor Republicans will be entirely happy with what I'm advocating. Some Republicans have proposed doing away with Fannie and Freddie entirely while Democrats will be reluctant to see quotas for low- income loans go away.
True, in a perfect world, Republicans and Democrats in Congress would hash out their differences and bring Fannie and Freddie back to life. But that’s not our world. The Obama Administration should do what it needs to do to end a situation that’s hurting would-be-homeowners and serving as a drag on the broader economy.
Rossi is an executive-in-residence and professor of the Practice at the Robert H. Smith School of Business, University of Maryland.