Fannie and Freddie on Steroids

A corollary to Shakespeare’s adage “A rose by any other name would smell as sweet” is that “garbage by any other name would smell as awful.”

The latter seems apropos to the “reform” of the government-sponsored housing enterprises, Fannie Mae and Freddie Mac, introduced by senators Tim Johnson, (D., S.D), and Mike Crapo, (R., Idaho) — the top Democrat and Republican on the Senate Banking Committee — and set to be marked up on Tuesday. A new letter signed by 26 conservative and free-market groups — including the Competitive Enterprise Institute, Club for Growth, FreedomWorks, Americans for Tax Reform, National Taxpayers Union, and the American Family Association — argues that Johnson-Crapo “does not constitute real reform, but an expansion of the type of government intervention that fueled the housing crisis in the first place.”
While the media often characterizes this plan as “ending” Fannie and Freddie, most of the two government-sponsored enterprises’ functions would simply be transferred to a new giant government entity, the Federal Mortgage Insurance Corporation — or what we might call Feddie Mic. Not only would the government’s role in subsidizing and micromanaging housing not be reduced, in many ways it would be substantially increased.
Further, the legislation would create an explicit taxpayer guarantee of the government-sponsored enterprises’ $5.6 trillion in debt, and housing “trust funds” would be created anew within Feddie Mic. These trust funds, a brainchild of former representative Barney Frank (D., Mass.), are potential slush funds for politically motivated “housing advocates” such as the now-defunct ACORN.

Worst of all, and sending the worst possible signal to the potential private-sector investors who are needed for a private housing market to thrive, Fannie and Freddie’s shareholders would be wiped out permanently under the bill’s Section 604.

Fannie was created as a government agency in 1938 and spun off as a government-sponsored enterprise (GSE) in 1968. Freddie was created as a sister GSE two years later. Even though they had private shareholders, they always retained government privileges: They were exempt from state and local taxes, and, importantly, each had a $2 billion line of credit with the U.S. Treasury.

Back in 2000, the Competitive Enterprise Institute’s founder, Fred Smith, predicted in his testimony before Congress that “as long as the [government] pipeline is there, it’s very expandable. . . . It could be $200 billion tomorrow.”

Many dismissed Smith’s prediction at the time, but it turns out he underestimated the ultimate tab to taxpayers for the bailout orchestrated by the Bush administration, which put the GSEs under conservatorship at the height of the financial crisis in 2008. While the Obama administration estimates the cost at $188 billion, the Congressional Budget Office’s “fair value” accounting puts it at $317 billion.

But the real cost to taxpayers came from Fannie and Freddie’s role in partnering with banks in issuing new subprime mortgages. As documented in the groundbreaking book Reckless Endangerment, co-authored by New York Times’ Pulitzer Prize–winning business columnist Gretchen Morgenson and financial analyst Joshua Rosner, the GSEs had key roles in providing invaluable assistance to bad actors in the private sector, including the notorious Countrywide Financial.

The American Enterprise Institute’s Peter Wallison, a commissioner of the congressionally created Financial Crisis Inquiry Commission, points out in a Wall Street Journal op-ed that in September 2008, “half of all mortgages — 28 million — were subprime or otherwise risky and low-quality,” and of these, “74 percent were on the books of government agencies, principally the GSEs.”

After years of minimizing the role Fannie and Freddie played in the crisis, many liberals as well as longtime housing “subsidy suckers” (in the parlance of the intrepid Washington Examiner columnist Timothy P. Carney) in the real-estate and construction industries are hailing the Johnson-Crapo “reform” and saying the GSE model has “failed.” But it’s important to understand why they believe it has failed. Incredible as it may seem, they believe the GSEs are being too stingy and see Johnson-Crapo’s proposed Feddie Mic as a way of prying open government-backed credit spigots even further.
For instance, in Friday’s Wall Street Journal, Jason Furman and James Stock, respectively the chairman and a member of President Obama’s Council of Economic Advisers, hit Fannie and Freddie in an op-ed for “not making transparent sustained contributions to affordable housing.” They call for a “reformed housing finance system” in which the government would “stimulate broad access to mortgages for historically underserved communities.”

Under Johnson-Crapo, Feddie Mic would replace the GSEs’ purchase of mortgages by serving as the backstop for mortgage-backed securities issued by financial powerhouses. But this is likely to make the moral hazard even greater and entrench “too big to fail” even further. As Reckless Endangerment co-author Rosner has written, “Unfortunately, the bill replaces Fannie and Freddie with an untold number of new government-sponsored enterprises by handing a massive taxpayer backstop to the nation’s largest banks”

Much is made by Johnson-Crapo supporters of how private owners will take at least 10 percent of the loss on mortgage-backed securities that Feddie Mic insures. But that still leaves 90 percent to be absorbed by Feddie Mic, and even 100 percent when the government declares “unusual and exigent circumstances” in the housing market.
Other beneficiaries would be big-government housing advocates, since the “Housing Trust Fund” the Johnson-Crapo plan creates within Feddie Mic bears a remarkable similarity to that which used to exist within the GSEs. The trust fund lay mercifully dormant under the financial management of the GSEs by Bush administration holdover Ed DeMarco.

But advocates are hoping DeMarco’s replacement, former representative Mel Watt, a North Carolina Democrat, will restart it. And now, the fact that a bipartisan “reform” plan gives the “trust fund” its blessing will only strengthen Watt’s hand in bestowing this patronage.

And to foot the bill for this generosity to both advocacy groups and businesses, Johnson-Crapo codifies the Obama administration’s policy of wiping out completely Fannie and Freddie’s private shareholders, including community banks, pension funds, and middle-class investors.

In August 2012, then–treasury secretary Tim Geithner issued the “Third Amendment” to the GSE conservatorship in which all profits would be siphoned off to the U.S. Treasury Department in perpetuity, even after the GSEs paid back what they owed to taxpayers. Section 604 of Johnson-Crapo states that the Obama-Geithner policy “should not be amended, restated, or otherwise changed.”

As NRO’s Jillian Melchoir has written of the Obama-Geithner earnings raid codified by Johnson-Crapo, “It would have been one thing if the Treasury had barred shareholders from profits until taxpayers were repaid for the Fannie and Freddie bailouts, but an undisclosed and permanent ban on profits is extreme.” Ike Brannon and Mark Calabria make the point in a recent paper for the Cato Institute, “If we hope to rebuild our mortgage finance system on a foundation of private capital, then property and contractual rights must be respected.”

The best option to end the risk posed by the GSEs to taxpayers and the economy is an orderly liquidation of their assets, with no government-backed entity to replace them.

As Fred Smith urged Congress in 2000 — to mostly deaf ears — policymakers should “develop a divestiture or breakup plan for Fannie and Freddie.” And in such a plan, as in traditional bankruptcies, the rights of both taxpayers and private investors should be sacrosanct.