Is It Time To Replace Fannie Mae and Freddie Mac?

An old idea with new make-up is floating around Washington, an effort to once again shut down Fannie Mae and Freddie Mac and shift mortgage dollars into private pockets, this time under the guise of bi-partisanship.

Fannie and Freddie are government-sponsored enterprises (GSEs) that represent  much of the secondary market, an electronic platform on which mortgages are bought, sold, insured and guaranteed. It is the secondary market which makes possible vast sums of cash for the American housing sector and assures that  rates are largely cheap and uniform nationwide.

The Housing Commission of the “Bipartisan Policy Center” — a group which took in nearly $22  million according to a recent financial report — does not especially care for the current set-up. Instead, it has proposed a “new housing finance system that calls for a far greater role for the private sector, a continued, but limited role for the federal government, the elimination of Fannie and Freddie, and reform of the Federal Housing Administration to improve efficiency and avoid crowd-out of private capital.”

While closing Fannie and Freddie is always a cause for attention; the more interesting part of the Commission’s proposal concerns that “limited role” of the federal government.

“The commission proposes to replace the GSEs with an independent, wholly owned government corporation — the “Public Guarantor” — that would provide a limited catastrophic government guarantee for both the single-family and rental markets. Unlike the GSEs, the Public Guarantor would not buy or sell mortgages or issue mortgage-backed securities. It would simply guarantee investors the timely payment of principal and interest on these securities.”

Right now the government, which nationalized Fannie and Freddie in 2008, already provides such a guarantee. That must be the case, otherwise, why would the Feds have spent $187 billion supporting these two entities?

It should be mentioned that roughly $50 billion of the $187 billion laid out for Fannie and Freddie has already been repaid and more is on the way, repayments which give some hint at the profits available to the GSEs — or their replacements.
The commission argues that we need to reform Fannie and Freddie because “a successful housing finance system should maximize the range of ownership and rental housing choices available at all stages of our lives.”

Has anyone checked the housing market lately? According to the National Association of Realtors existing home prices in January were up 12.3 percent from 2012, while unit sales were up 9.1 percent from a year earlier. These figures don’t suggest that either ownership or rental choices have been curtailed or that the secondary market is not working.

Dumping Fannie and Freddie simply means something else will have to do their job in the secondary market. If that something else is insured by a “Public Guarantor,” then what is the limit of the taxpayer’s exposure? Is it $187 billion? Is it more? Is it less? It certainly can’t be zero.

And what happens in the case of fraud? Are taxpayers going to be responsible when lending or securities rules are breached?

Chris Whalen, the author of Inflated: How Money and Debt Built the American Dream, and the executive vice president, managing director for Carrington Investment Services, LLC, a unit of Carrington Holding Company, writes that “under legal tests stretching from 16th Century UK law to the Uniform Fraudulent Transfer Act of the 1980s, virtually none of the mortgage backed securities deals of the 2000s met the test of a true sale. Under the UFTA standard, for example, any transfer which is intended to leave the transferor with insufficient capital is a fraud which converts a ‘sale’ into a ‘secured borrowing’ by the transferor.” (See: Zombie Love,True Sales and Why “Too Big To Fail” is Really Dead on

Replacing Fannie and Freddie with private-sector substitutions does not mean mortgage costs will go down or that taxpayer liabilities will decline, it means only that profits from the secondary market will go into different pockets.

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