Treasury Secretary Henry Paulson's surprisingly aggressive move to essentially nationalize, if only temporarily, struggling mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) raises a host of questions, not least of which is how much it will ultimately cost U.S. taxpayers to bail them out. But the biggest question of all centers on how the two entities should be restructured once the immediate solvency crisis is past.
While the fate of Fannie and Freddie will not be decided until a new Administration and Congress take office, the battle lines already are being drawn. Critics have long argued that Fannie and Freddie were doomed by their odd hybrid nature as semipublic, semiprivate enterprises: The mortgage companies were supposed to earn rich profits for shareholders even as they were expected to foster public goals like keeping the mortgage market liquid and making homeownership affordable for millions of Americans. Now policymakers, backers, and critics alike have begun to weigh in on what promises to be an enormous fight over the future status and role of Fannie and Freddie.
"There is no script for this," says Howard Glaser, a senior housing official in the Clinton Administration and the former top lobbyist for the Mortgage Bankers Assn. who now runs the Glaser Group. "This debate is going to be front and center whoever comes in next year."
While both of the Presidential candidates pronounced themselves in support of the emergency bailout, the two men have very different views of the long-term role the mortgage companies will play. Republican contender John McCain was quick to argue that the mortgage giants should be shrunk down and privatized once they return to health. His opponent, Democrat Barack Obama, has stressed that the government must move carefully to ensure that whatever changes are made don't cause further disruption to the housing and financial markets.
Here's a look at three options being discussed in policy and financial circles, and what each would mean:
Stick with Uncle Sam
Given the inherent conflict the mortgage giants face in trying to meet public policy goals while keeping private shareholders happy, one camp argues that the firms should be officially nationalized. Fannie and Freddie would then become government agencies focused solely on their public mission of providing liquidity to the housing market and to promote homeownership for low-income Americans—much like Fannie was until 1968, and like Ginnie Mae, which securitizes Federal Housing Authority loans, has always been. Under this scenario, Fannie and Freddie would no longer be allowed to invest in mortgage-backed securities for their own portfolio—the primary source of their current problems.
A downside of this approach, however, is that the two entities may have trouble recruiting strong executives and managers. Political interference could also become worse. "There's a danger that they become even more susceptible to political pressures and pork barrel projects than they already have been," says Robert Litan, vice-president for research and policy at the Kauffman Foundation.
Fannie and Freddie, 2.0
Another, far larger camp wants to see Fannie and Freddie considerably downsized and much more tightly regulated. But they also want the companies to retain some form of public shareholders, so that capital from investors could continue to flow into the mortgage markets. Their main function would continue to be buying up mortgages, breaking them up, and repackaging them into securities to be sold off to banks and other investors, and to ensure the market remains liquid even in times of stress.
Susan Wachter, a professor of real estate and finance at the Wharton School at the University of Pennsylvania, argues that preserving that role as "buyer of last resort" will be critical. She points out that while private buyers and securitizers of mortgages have all but disappeared over the past year as the crisis has worsened, Freddie and Fannie have kept the market functioning. "There is no private-label market for mortgage-backed securities when things get bad. What would we do without Fannie and Freddie?" she asks.
Key congressional Democrats, such as Representative Barney Frank and Senators Charles Schumer and Christopher Dodd, have also long defended the other public mission of the government-suppported enterprises, which is to help low-income Americans purchase homes. Support for that mission is likely to remain strong, no matter what final form the two mortgage giants take.
Under an arrangement in which Fannie and Freddie are shrunk, however, shareholder returns could be capped, as would management's freedom to develop new products or otherwise innovate. Treasury officials have cited public utilities as a potential model: Utilities can tap private capital markets while still operating under regulations that require them to meet public needs. Their ability to invest for their own portfolio would also be severely limited, if not eliminated altogether.
"Now that Paulson has pulled the trigger, they no longer have a private moneymaking function," says an aide to a Senator who will play a key role in the debate. "The question is whether they ever will have one again. No one knows."
Sell 'Em Off
Conservatives who have long waged war against what they see as Fannie and Freddie's government-subsidized advantage in the market have no doubt about what should happen: They'd follow former Fed Chairman Alan Greenspan's advice. He argues that once the government has sold off enough of their assets and injected enough capital in them to make them viable again, Fannie and Freddie should be broken up into smaller pieces—to eliminate the "too-big-to-fail" risk—and sold off. The smaller, succeeding entities would be profit-driven, and answerable only to shareholders. But they would also lose the implicit government backing that gave them lower borrowing costs and fueled appetite for their bonds among investors, including foreign central banks.
Peter Wallison, who served as general counsel for the U.S. Treasury under Ronald Reagan and now is a prominent critic of the mortgage giants at the American Enterprise Institute, goes even further. He argues that no taxpayer money should go into recapitalizing them at this point.
"Taxpayer money is a gift to these people; there's no need for capital investment in these companies," Wallison says. He adds that a liquid market for mortgage securities will return again when enough banks and other buyers are financially strong enough—and certain enough about value—to participate in the market.
Still, Wallison is skeptical that anything close to this kind of radical reform will happen. With the decision over final structure now essentially in congressional hands, he—like many others on both sides of the aisle—predicts that a modified, trimmed-down version of the mortgage giants' current structure is most likely to result at the end of the day.
Business Exchange related topics:Fannie Mae and Freddie MacMortgage CrisisMortgage Lenders