Fannie and Freddie Are on the Mend. It’s Time to Fix Them
Followers of the American housing catastrophe were greeted with encouraging news this week. Fannie Mae, the government-owned mortgage-finance company, reported a $2.7 billion first-quarter profit. For the first time since its 2008 government seizure, it didn’t need to tap the U.S. Treasury, even after paying a huge dividend. Freddie Mac, Fannie’s sibling, similarly reported a profit but needed a small infusion of capital after paying the U.S. a dividend.
These signs of renewal may offer a tempting excuse for President Barack Obama to hold off on reforming Fannie and Freddie. This would be a mistake.
For the last three years, the administration has resisted touching Fannie and Freddie out of fear of doing more harm than good to a sick housing market. The strategy, while understandable, has resulted in a sector that is almost totally dependent on the government: More than 90 percent of new mortgages are owned or guaranteed by Fannie, Freddie or the Federal Housing Administration. Private capital is almost nonexistent. As long as Fannie and Freddie have an outsized presence, plus an endless stream of taxpayer subsidies, the private sector will stay on the sidelines.
What can be done? We suggest winding down Fannie and Freddie. This would involve slowly selling off the mortgages and securities the firms now own and honoring their legacy obligations, including the debt Fannie and Freddie have sold to investors around the world.
The next step would require the creation of an independent government agency, possibly one modeled after the Federal Reserve or Federal Deposit Insurance Corp. and ideally one whose mandate is to supplement, not substitute for, private capital. It most definitely shouldn’t have dual responsibilities to shareholders and taxpayers, which is how Fannie and Freddie got into deep trouble during the housing boom.
The new agency’s mission should be narrow: To provide insurance on mortgage-backed securities issued by private-sector entities. Only loans that meet certain tests, including a 10 percent down payment and borrower documentation showing the loan is affordable, would qualify. Such mortgage-backed securities have long provided the housing market’s grease by moving risk off lenders’ books and freeing them to lend again. But private-sector MBS issuance to $1.9 billion in 2011 from $567.8 billion in 2006, according to Bloomberg Government.
The guarantee should be priced to reflect loan risk and protect taxpayers as much as possible. The government could even tie the size of the loans it backs to the economic cycle. When housing starts decline -- suggesting market weakness -- the government could increase the cap on a conforming loan from, say, $500,000 to $600,000.
The guarantee fee should gradually rise as the U.S. transitions away from Fannie and Freddie. Needless to say, any transition should be slow and measured to avoid further weakening the housing market.
The housing crisis has exacted a brutal toll, with home prices falling more than 30 percent since 2006, wiping out $7 trillion in household wealth. Recently, however, we see encouraging -- if mixed -- signs that the market is hitting bottom. U.S. housing starts dropped in March, yet they’re still about 10 percent higher than a year ago. Building permits are 30 percent higher than this time last year. Homebuilders say new-home orders are increasing, no doubt buoyed by historically low interest rates. The average rate on a 30-year mortgage was 3.83 percent on May 10, an all-time low.
It’s worth pointing out that housing directly accounts for 5 percent of gross domestic product. It is crucial to household wealth and the overall economy and therefore should be as central to this year’s presidential campaign as jobs and taxes. Obama and Mitt Romney, the likely Republican nominee, should be pressed to explain what they would do, not just to repair the housing-finance companies, but to create the conditions for a smaller, less taxpayer-dependent mortgage market.
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