Fannie-Freddie White House Sham Summit Produces Short-Sighted Solutions

After ramming through a “financial reform” bill that increases government controls on such “ants” (hat tip to House Minority Leader John Boehner’s comments–distorted by the press–in full context) as orthodontists with installment plans and retail stores with layaway plans, but leaving the elephants Fannie Mae and Freddie Mac to roam free with unlimited taxpayer backing, the Obama administration is today holding a promised summit to at least discuss putting some kind of fence around the government-sponsored enterprises.

But given the controlled atmosphere of the summit–which President Obama is not even attending, preferring instead to campaign on the West Coast–any fence this Obama administration will build will be very easy for the housing elephants to trample over.  Geithner set the tone of the summit this morning with what Fortune calls his “spilled milk” opening remarks attempting deflect criticism of Fannie and Freddie’s losses. “There is nothing we can do to decrease the significant losses Fannie and Freddie incurred ahead of this crisis,” he said.

So far, the firms have taken $15o billion in taxpayer aid.  The Treasury Department’s “Christmas bailout” of the GSE’s–the December 24 order removing the caps of $200 billion dollars that Treasury was authorized to spend on each of the two mortgage underwriters–exposes the American taxpayer to unlimited liability for the entities and their potential new missteps.

Competitive Enterprise Institute President Fred Smith had long warned about the systemic risk Fannie and Freddie posed to the financial system, warning as early as 2000 that their implosion could cause a taxpayer bailout of as much as $200 billion.  Members of Congress expressed shock and outrage, but Smith turned out to have underestimated the ultimate costs.

And new research shows that rather than being “late to the subprime party,” as some press narratives had describe it, Fannie and Freddie created and drove the subprime market as early as the ’90s. Indeed, according to housing expert Edward Pinto, Fannie’s former chief credit officer who has presented his findings before Congress and should himself be asked to testify before the commission, millions of mortgages to borrowers with credit scores of less than 660–considered by prominent researchers to be the dividing line for subprime loans–had been labeled by Fannie and Freddie as prime going back as early as 1993.

In his writings for the American Enterprise Institute, Peter Wallison, now also a commissioner on the Congress-created Financial Crisis Inquire Commission,  noted that this misrepresentation by the government-backed mortgage giants could have itself been a major factor in inflating the housing bubble. “Market observers, rating agencies and investors were unaware of the number of subprime and Alt-A mortgages infecting the financial system in late 2006 and early 2007,” he wrote.

Simply making the government support of Fannie and Freddie direct–an idea conference attendee Bill Gross of PIMCO proposed and Geithner implied support for–may produce slightly more honest accounting. But it would continue the distortion of government support for housing that is hurting both short-term growth by channeling private funds to government-guaranteed housing instead of more innovative economic  sectors, and long-term prosperity by adding possibly $1 trillion to U.S. national debt.

CEI has long advocated that the government both break up Fannie and Freddie and withdraw government support. More and more of the American public is coming to agree. A CNBC poll of its viewers this morning found that 68 percent believe that the GSEs are no longer necessary. While the poll is not scientific, it is significant, because CNBC’s viewer are not as conservative as those of FOX News or FOX Business.

Winding down Fannie and Freddie will not be easy, but it will not be the horrendous disaster many are claiming. Interest rates would likely go up, but housing prices will almost certainly go down, meaning that housing would likely hit equilibrium for credit-worthy borrowers with modest incomes. As CEI’s Smith has noted, there are “many American dreams,” and the claim of politicians of both parties that housing is intertwined with our economy is a circular argument. This intertwining is itself due to the government’s backing of housing.