Would the U.S. Be Better Off Without Fannie Mae and Freddie Mac?

Some people reflexively oppose whatever Republicans support, while others just as automatically come out against anything Democrats like. That simple, grumpy rule of thumb doesn’t work with Fannie Mae and Freddie Mac, because many conservative Republicans and liberal Democrats are taking the same side: They’re against the latest bill to close down the mortgage giants. For different reasons, of course. This forces the rest of us to actually think for a moment about who’s right.

On Thursday a narrow bipartisan majority of the Senate Banking Committee voted to send along to the full Senate a bill that would wind down Fannie Mae and Freddie Mac over five years. But because of all the opposition from left and right, the bill is unlikely to get a floor vote this session. So you still have some time to figure out which side to take. Here’s a quick primer on the issues:

Who are Fannie and Freddie again?
Not who, what. The two companies support the U.S. housing market by buying mortgages from the banks that originate them and bundling the loans into securities that they then sell to investors. They guarantee timely payment of principal and interest on the underlying loans, and they keep some of the loans and securities for their own portfolios.

Didn’t they go out of business?
Almost. They were blindsided by the housing bust and lost so much money that in 2008 they were forced into conservatorship, which basically means the federal government took over their management and eventually injected almost $190 billion to keep them solvent and operating.

What happens next?
The main two options are keeping the status quo vs. gradually shutting Fannie and Freddie down. The bill just voted out of the Senate Banking Committee would replace the mortgage giants with a much smaller, focused operation. There would still be federal insurance for mortgage bonds to reassure investors and keep the loan money flowing. But the federal (i.e., taxpayer) responsibility wouldn’t kick in until private investors absorbed some losses.

Who’s against this?
On the right, Senator Richard Shelby, an Alabama Republican, calls the bill “a complicated government-run framework that I believe overexposes the American taxpayer and creates more problems than it solves.” On the left, Senator Elizabeth Warren, a Massachusetts Democrat, said, “This bill does not do enough for housing-market needs of middle-class America.” She added that the bill “would cut the pool of qualified borrowers by 20 percent.”

Who has the better argument?
That’s a political question, of course. People who worry more about taxpayers’ exposure to losses tend to dislike any reform that continues federal insurance of mortgages, while those who care most about keeping mortgages affordable want to preserve a big role for Fannie and Freddie or some other government-backed institution.

What are the other options?
Jeb Hensarling, the Texas Republican who chairs the House Financial Services Committee, says the answer is to remove artificial barriers to private-sector involvement. His bill is called the PATH Act, for Protecting American Taxpayers and Homeowners. At the other end of the political spectrum, California’s Maxine Waters, the ranking Democrat on Hensarling’s committee, wants to replace Fannie and Freddie with a securities issuer that would be owned by a cooperative of lenders, while keeping an explicit government guarantee of mortgage-backed securities. For much more detail on these and other ideas, check out this thorough explanation from the Structured Finance Industry Group (PDF).

What happens in the meantime?
Fannie Mae and Freddie Mac will continue to play a huge role in housing finance for the foreseeable future. That became clearer than ever on May 13, when Melvin Watts, director of the Federal Housing Finance Agency, said he’s in no hurry to wind down the mortgage companies; that would be up to Congress. “I don’t think it’s the FHFA’s role to contract the footprint of Fannie and Freddie,” he said in an appearance in Washington.

    Before it's here, it's on the Bloomberg Terminal.