Reform of Fannie Mae and Freddie Mac is long overdue
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In "The Big Short," which was based on the true story of a handful of investors who predicted the disastrous housing market collapse of 2007 and profited handsomely from it, there was plenty of blame to go around. However, two guilty characters were hardly mentioned in either the book or the movie: the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).

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In fact, the vast majority of the analysis surrounding the causes of the Great Recession avoids casting aspersions on these two government-sponsored enterprises (GSEs). With their government charters and implied guarantee that their investments are backed by the full faith and credit of the U.S. government, the GSEs have the best of both worlds: They enjoy privatized profits (where only the shareholders benefit), while all losses are socialized (where the taxpayers pick up the tab).

In the early 2000s, members of Congress from both sides of the aisle put blinders on when skeptics sounded Cassandra-like warnings about the GSEs. They were told that the size and market concentration of the GSEs made them too big to fail, even though Fannie and Freddie claimed that they were private companies, independent of the government. Members of Congress were admonished many times that taxpayers would be on the hook if anything went wrong with the GSEs, yet nothing was done.

The housing market finally collapsed in 2007, and the financial crisis from which the U.S. economy still struggles to emerge ensued shortly thereafter in 2008. The resulting $189 billion taxpayer bailout is the largest in American history.

After the bailout, Congress created the Federal Housing Finance Agency (FHFA), a regulator that put the GSEs into conservatorship. Those who wanted to ensure that taxpayers would never again be on the hook for such staggering losses believed that the next step should have been a complete "wind down," severing all ties to government guarantees, with no more government charter, no more presidential appointees and no more liberal line of credit from the U.S. Treasury. In other words, privatization.

But the GSEs have been counting on memories being short.

Hedge fund investors, who paid pennies on the dollar for common stock in Fannie and Freddie, are hoping to get the GSEs recapitalized, so that they can conceivably emerge from conservatorship unscathed. This concept is being referred to by the seemingly innocuous phrase "recap and release."

Unfortunately, such rhetoric may fog normally sensible thinking. Experience teaches that reforms will not occur unless Fannie and Freddie are kept in a box, beyond which they cannot run roughshod over the mortgage market with their reckless policies. At the same time, any "profits" that they generate are regularly swept by the Treasury (rather than retained as operating capital) into a general "slush fund" that is used to fund the administration's pet projects or to mask larger deficits.

On the other hand, if Fannie and Freddie were allowed to retain their profits, it would create a false impression that they might somehow be on the path to fiscal recovery, in turn feeding the perception that they should be able to resume their earlier business practices; i.e., controlling the overwhelming majority of mortgage loans, with the taxpayers' continued backing.

The GSEs themselves have not demonstrated any serious interest in significant reforms. They continue to impose guarantee fees and price adjustments far in excess of real credit risk. Since profits go straight to the Treasury, the GSEs have no incentive to control costs. To the contrary, expenses have increased by more than $1.1 billion, or 36 percent, since 2012.

Under the preferred stock agreement that mandated a downward glide path for retained capital ($1.2 billion in 2016, $600 million in 2017 and zero in 2018), the GSEs have spent wildly. They have sought to reconstitute their political influence machine, hiring more than 1,000 people, and sending teams to conferences and events throughout the country, spreading the gospel that the GSEs are serving the market just fine. By their narrative, all is well.

But homebuyers, homeowners and taxpayers deserve more reliable choices. For one thing, the private market should take on the credit risk of mortgages from the first dollar of loss before any government guarantee is applied. The goal, of course, is to eliminate the need for any government guarantee. Until then, the government should only be in a catastrophic backstop position, with the guarantee fee reduced to match its significantly reduced exposure.

For now, though, the GSEs bide their time, certain that memories will continue to fade. Unless and until their advantageous government guarantees are withdrawn, they have nothing to lose. But taxpayers do.

Schatz is the president of Citizens Against Government Waste.