Future of Fannie and Freddie remains unclear

The federal takeover of Fannie Mae and Freddie Mac recently could create the opening many have long hoped for – to alter, diminish or eliminate the roles of the government-sponsored mortgage giants.
Some industry observers worry that a world in which the companies have less influence will mean more expensive mortgages and fewer types of loans. Others say they believe that downsizing or killing off the entities would allow the markets and businesses to more appropriately evaluate risk, curtailing the excesses that led to the spectacular real estate collapse.


The wrangling over the future of Fannie and Freddie could take years and will likely unfold along predictably partisan lines, with Democrats by and large pushing to protect the companies’ role in providing affordable mortgages for low- and moderate-income families and Republicans arguing that the free market can meet those and other housing market needs better than a quasi-governmental agency can.

Committees in both houses of Congress will take up the question this week during hearings on the government seizure. The debate won’t begin in full until next year, after the new administration is in office, said Steven Adamske, a spokesman for the House Financial Services Committee and its chairman, Rep. Barney Frank, D-Mass.

In the coming months, committee staff will begin analyzing various scenarios, Adamske said. But the battle lines are reportedly already forming between:

  • Making the agencies completely public;
  • Allowing private industry to take on more or all of their functions or fully privatizing the agencies themselves;
  • Allowing them to proceed essentially as is, but with stricter oversight.

Fannie and Freddie own or guarantee more than $5 trillion in mortgages, about half the total in the nation. The government-sponsored enterprises were designed to boost home ownership and improve affordability. They keep money moving through the mortgage market by buying loans, packaging them into securities and selling them to investors.

Until now, the securities have not been officially insured by the government, but the strong sense was that Uncle Sam would step in before letting the companies or their products fail. That allowed Fannie and Freddie to borrow at discounted rates and created a stable, secondary market that helped other businesses issue affordable loans.

But the companies racked up billions in losses as foreclosures soared, hamstringing their ability to raise funds and ultimately leading to the Treasury Department takeover that put taxpayers on the hook for potentially hundreds of billions of dollars.

Many in the real estate industry agree that new protections are necessary to prevent such a nightmare scenario again but believe it’s critical to preserve the overall structure and function of the institutions.

Without the implicit government backing that the government-sponsored enterprises have long enjoyed, the cost of mortgages would rise, putting homeownership out of reach for more families, said Joel Singer, executive vice president of the California Association of Realtors. On top of that, the variety of loans would likely shrink, as fewer banks will be willing to issue and hold the long-term, fixed-rate mortgages that government-sponsored enterprises specialize in.

Ensuring capital flows
Ed Craine, vice president of the California Association of Mortgage Brokers, added that the companies play a crucial role in down markets that private industry can’t or won’t fulfill: ensuring capital flows that keep the markets liquid and provide a brace for housing prices. Fannie and Freddie have accounted for about 80 percent of loan originations during the credit crunch, as private companies severely cut back lending.

“What would happen to the housing market right now if we didn’t have Fannie and Freddie, no investors were willing to buy loans and bankers were under pressure because of other losses to cut back on lending?” he asked. “You’d have a housing market in much further contraction than it is now.”

Part of the problem?
Those in favor of making Fannie and Freddie private or allowing private industry to take over their roles cite long-standing ideological and economic criticisms of the entities, at least as they existed until last weekend’s takeover.

The implicit government guarantee allowed the companies to raise money at favorable rates and pump it into the market, creating dangerous market distortions that set the stage for the prolonged downturn, said Lawrence McQuillan, director of business and economic studies at the Pacific Research Institute, a free-market think tank in San Francisco.

With so much cheap money, banks battled each other to issue increasingly risky loans, more and more people were given mortgages they couldn’t afford and investors bought packages of loans they didn’t fully understand, McQuillan said.

“If you removed this artificial stimulation of the housing industry, you’d get a much more sustainable flow of money,” he said. “The lender would be far more responsible in terms of their initial decision making.”

Fannie and Freddie were critical at one point in the nation’s economic history, but have outlived their usefulness, said Esmael Adibi, director of the Anderson Center for Economic Research at Chapman University in Orange. The expanded private mortgage industry has shown it can sustain its own secondary mortgage market, he said.

He acknowledged that rates may climb more and lending could decline further during real estate slumps without a government safety net but said that’s the appropriate and even necessary market response to shifting economic realities.

Still others object to the quasi-governmental status of the companies, which allowed them to raise money at preferable rates without obligating them to share the proceeds with those who would be called on to bail them out in the event – now realized – of their downfall. As the saying goes: Privatizing the profits, socializing the risks.

Best of both worlds?
The best solution may be a hybrid model, said Jim Wilcox, professor of financial institutions at UC Berkeley and a former economist with the Federal Reserve. The entities’ mortgage-buying and -backing role could become private while the affordable housing and “lender of last resort” functions are tucked into a new or existing public agency, perhaps the Federal Housing Administration.

“The more explicit and the less implicit the better,” he said.

Most feel the ultimate shape of the government-sponsored enterprises will largely depend on the makeup of the next administration and Congress, as well as the state of the economy and real estate markets in coming months. The major party presidential candidates have both provided indications of their goals for the future roles of institutions.

At a campaign event in Davenport, Iowa, on Aug. 25, Democratic nominee Sen. Barack Obama said the status of the mortgage companies should be explicitly defined.

“We have to go ahead and make a decision,” he said. “If these are public entities, then they’ve got to get out of the profit-making business. And if they’re private entities, then we don’t bail them out.”

On the July 24 St. Petersburg Times opinion page, Republican nominee Sen. John McCain wrote: “If elected, I’ll continue my crusade for the right reform of the institutions: making them go away.”

A spokesman for House Speaker Nancy Pelosi, D-San Francisco, said she wouldn’t comment on the appropriate fate of Fannie and Freddie, preferring to await the recommendation of Frank after the planned hearings. Frank spokesman Adamske also didn’t commit to a position, saying: “It’s going to take some time to get it right, to figure out how we go forward in the future.”

Frank has already provided a strong hint that he’s at least against downsizing the government-sponsored enterprises. When asked by the Wall Street Journal about the Treasury Department’s intention to begin reducing the companies’ portfolios in 2010, as part of the takeover plan, he said: “Good luck on that.”

“The main goal,” Pelosi spokesman Brendan Daly said in a statement, “is to ensure that the interests of taxpayers are protected and that low- and moderate-income Americans continue to have access to affordable mortgages.”

Some say a final decision on the fate of Fannie and Freddie could take two years or more. For the foreseeable future, most believe government’s principal role will be to insert untold billions in an effort to make the companies whole, ensure liquidity in the mortgage market and assuage nervous investors around the globe.

E-mail James Temple at [email protected].

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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