Unfortunately in its section on the government-sponsored housing entities Fannie Mae and Freddie Mac, the plan would actually expand the federal guarantees in the housing sector. This expansion of the housing role cancels out the two constructive suggestions offered by the plan for the GSEs and would make things worse.
The plan commendably calls for an end to the conservatorship of Fannie and Freddie, in which the government has owned 79.9 percent of each of them since the Bush administration took them over when the financial crisis hit almost a decade ago in 2008. As I and others have documented, Fannie and Freddie’s lowering of lending standards for the mortgages it purchased in the decade prior to the crisis.
As I wrote in a recent paper, “In effect, the GSEs were pressured to ‘roll the dice,’ in the words of Rep. Barney Frank (D-MA), with ‘affordable housing’ goals and looser standards for mortgages. Frank pushed this agenda during his time as ranking minority member, and later chairman, of the House Financial Services Committee.”
What’s more, as American Enterprise Institute scholars Peter Wallison and Edward Pinto have documented, Fannie and Freddie began classifying as “prime” many loans earlier classified as “subprime,” because the borrowers had FICO credit scores of less than 660. These looser standards spread across the mortgage market, leading private banks to make loans of even lower quality, paving the way for the financial crisis.
Yet the federal conservatorship hasn’t cured these problems, it made them worse. Today, Fannie and Freddie and other government back nearly 90 percent of U.S. mortgages, compared to just under 50 percent in the years before the crisis. And under Federal Housing Finance Agency Director Mel Watt, the regulator of the GSEs, Fannie and Freddie have once again started purchasing loans with down payments as low as 3 percent!
Yet the president’s reorganization plan could make things even worse by allowing more firms to get explicit government guarantees to buy mortgages. Yes, it does end the conservatorship and remove Fannie and Freddie’s federal charters granted by Congress. The plan rightly states that “competition to the duopolistic role played by the two privately-owned GSEs would be an essential element of reform to decrease moral hazard and risk to the taxpayer.”
But then the plan makes clear that it means taxpayer-subsidized competition for both Fannie and Freddie and potentially dozens of new entrants. Both Fannie and Freddie and their competitors “would have access to an explicit Federal guarantee for mortgage-backed securities (MBS) that they issue. Such a guarantee would be on-budget and fully paid-for.”
The plan does state that there would be capital and underwriting standard for housing firms that receive the guarantee. But it doesn’t specify what they would be. And the fact that the plan calls for “affordable housing” goals similar to those that exist now indicates the underwriting would be pretty loose. It does no favor to taxpayers or those involved to give a mortgage to those who are strapped for cash. For those individuals, “affordable housing” should mean renting. It’s another debate whether rent should be subsidized, but mortgages certainly shouldn’t be from a simple common-sense perspective.
Real reform would be phasing out Fannie and Freddie and replacing them with nothing. It’s not any more logical to have government-sponsored enterprises for mortgages than it would be for car or computer loans.
As I concluded in my paper, “A consumer-driven marketplace where mortgages are neither subsidized nor heavily regulated is the only option for a vibrant and stable housing market that makes housing widespread and affordable.”