Wednesday, December 16, 2009

Fannie and Freddie: Don't Privatize Them Again

For all practical purposes, Fannie Mae and Freddie Mac now belong to the federal government. They were taken over by the government in the late summer of 2008 and remain under federal control. There has been discussion of re-creating them as private entities with some federal participation (in the form of guarantees of mortgage-backed securities they issue) and a lot of regulation, including profit limitations.

This is weird. The problems at Fannie and Freddie stem to a large degree from their mixed private-public nature. They ostensibly were privatized, but investors assumed that they were implicitly backed by the government. Fannie and Freddie took undue advantage of that assumption and seized a very large part of the mortgage market. They had a competitive advantage from their presumed implicit government protection, and could outcompete truly private mortgage lenders. They used some of their copious profits to hire the biggest lobbying guns in Washington to stave off meaningful regulation and effective private sector competition. By becoming so large with the benefit of a presumed government safety net, they made it unavoidable that the government provide them with a safety net. Yet the profits from their salad days went to their private shareholders and high level executives. Taxpayers only got to hold a bag with some really stinky stuff in it, while their homes sank in value.

Since the 1930s, promotion of home ownership has been a federal policy. Fannie Mae was created in 1938 as a federal mortgage financier, and was publicly owned for 30 years. In 1968, Fannie Mae was privatized, to remove it from the federal balance sheet (and thereby lower the apparent amount of debt carried by the federal government). In 1970, Freddie Mac was created as a private entity whose mission was essentially the same as Fannie Mae's, in order to compete against Fannie Mae. (This was an early sub silentio admission that private mortgage lenders couldn't effectively compete against Fannie.) While these two behemoths were not explicitly included in the federal government's balance sheet, it had to continue backing them up, if only because the market believed it would. Thus, Fannie and Freddie always existed to serve governmental policies and have always been liabilities of the government, regardless of what did or did not appear on the federal balance sheet. The 2008 bailouts and takeovers of Fannie and Freddie only reinforce this reality.

We can't take the federal out of Fannie and Freddie. So we should take the private for profit interests out of them. Doing so would rationalize the way they operate. They'd no longer have the incentive to dominate the mortgage markets in order to pump up their revenues and balance sheets to satisfy the demands of shareholders for ever increasing share prices. Their executives would no longer obtain pecuniary benefits from using aggressive accounting to boost bonuses and stock prices, as was the case in the late 1990s and early 2000s. Nor would they hire droves of expensive and influential lobbyists to protect their franchises from both private sector competition and prudent federal regulation. Shareholders would not profit while taxpayers bore losses.

Fannie and Freddie should be reorganized as nonprofit entities, similar to the Federal Reserve Banks. Mortgage lenders that want to do business with Fannie and Freddie would become members and would capitalize them, like the member banks of the Federal Reserve system. Their boards should have a majority of public members. Current shareholders should be bought out at prices reflecting the ocean of losses the Fannie and Freddie have inflicted on taxpayers.

Such a structure would not impede the flow of capital into the housing markets. Indeed, by making federal backing for Fannie/Freddie underwritten mortgage-backed securities all the more clear, capital would flow more readily. For a point of comparison, look how easily capital flows into U.S. Treasury securities, notwithstanding their very low interest rates.

By removing private profit-seeking interests from Fannie and Freddie, we restore to public control entities that exist primarily to serve public interests. The 30-year mortgage is a creature of government policy--before Fannie, mortgages tended to be in the range of five years, with a 50% downpayment. Fannie was created specifically to make the 30-year mortgage available, and the arguments for continuing federal participation in Fannie and Freddie revolve around the need to ensure the availability of inexpensive 30-year mortgages. While public ownership and control aren't panaceas--it's easy to think of public programs that have been screwed up--the opportunities for private profit made the problems at Fannie and Freddie much larger than they would have otherwise been.

The federal government, through Fannie and Freddie, the FHA, Ginnie Mae, tax deductions and credits, Federal Reserve purchases of mortgage-backed securities, and other measures, has staged a enormous, gigantic, gargantuan intervention in the housing markets. America's capital has been steered toward housing and away from other investments. This intervention won't end; indeed, with the current housing slump, it's becoming even more extreme as buyer tax credits extend and expand. The wisdom of public subsidies for housing can and will be debated until the end of the republic, because that's how long they'll exist. But we can at least eliminate the potential for private profit at taxpayer risk--and the increased distortion of the mortgage markets it can create--and restore what has always been a public policy to public status.

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