How the Government Zombified Our Mortgage Giants

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Jimmy So
August 12, 2015

The American Dream is built upon American homes. "Most countries have socialized health care and a free market for mortgages. You in the United States do exactly the opposite," Mervyn King, the former governor of the Bank of England, once told business journalist Bethany McLean. If you own a home, chances are you took out a mortgage. And if you have a mortgage, chances are it is guaranteed by Fannie Mae and Freddie Mac, two corporations that were created to serve the American Dream of homeownership. "A nation of homeowners, of people who own a real share in their land, is unconquerable," in the words of Franklin D. Roosevelt.

Fannie and Freddie touch the lives of almost every American. Not only that, but since they bundle mortgage payments and sell them as prized securities to many foreign central banks, the companies reached into every corner of the world. But because Fannie and Freddie were set up as something between a private business and a government agency, the dominance they had over the mortgage market fated them to accumulate extreme wealth and power that were abused by executives who held sway over Congress and paid themselves hugely generous salaries.

This "government-sponsored enterprise" model was very controversial. And when bankruptcy—and global economic chaos—threatened Fannie and Freddie at the start of the 2008 financial crisis, the U.S. Treasury took the opportunity to put the GSEs into a life-support state known as "conservatorship," a limbo state that was supposed to be temporary.

Seven years after the meltdown, and Fannie and Freddie are back, profitable once again after weathering the crisis. But the government has not released them from conservatorship, all the while redirecting their profits toward reducing the federal deficit. Why does the government want them dead? How is the administration getting away with it? Will it ever succeed in killing them off?

That is the story McLean tells in her forthcoming work, Shaky Ground, which aims to start a discussion that has become necessary in Washington, as homeownership finance festers into the biggest unsolved issue left over from the financial crisis. Worse still, China and Japan are big owners of Fannie and Freddie securities, and they want to ensure that their investments are healthy and stable—which helps explain why the government does not wish to make any major moves that might rock the boat. As McLean's op-ed in July 20's New York Times points out, it is not practical to kill off Fannie and Freddie, but the current state is the worst of all worlds: 

We as a society want much of what they provide, which is relatively consistent access, through good times and bad, for a wide section of society, to a 30-year fixed-rate mortgage. ...

At a time of economic uncertainty, when income inequality is a major issue, it is also not a great thing for social cohesion to require those at the lower end of the income scale to start paying far higher rates for their mortgages than those at the upper end, which most analysts agree would be the case if purely private capital financed the mortgage market.

If we can’t do any better, isn’t it time to fix what we have and ease Fannie and Freddie out of conservatorship? The first step is to stop sending all their dividends to the Treasury. That would allow them to start rebuilding capital, eventually to a level substantially higher than what they were allowed to operate with before the crisis. Then, let’s devise a tighter regulatory structure, one that limits the businesses in which Fannie and Freddie can operate, limits the incentives of their management teams to take risk, and limits their ability to lobby. We could cap the returns to shareholders, as utilities do.

Franklin D. Raines, Fannie’s former chief executive, suggests structuring them like mutual insurance companies, which are owned by their policyholders, who would in this case be homeowners, rather than shareholders. A guarantee fund, modeled after the Federal Deposit Insurance Corporation, could support the companies in times of stress as the F.D.I.C. does banks. It would not be perfect. But if the alternative is doing nothing, it’s a whole lot better than that.

Read the entire piece at the New York Times, and preorder Shaky Ground, to be released on September 15. Visit our Events page for news of Shaky Ground's launch and McLean's book tour.

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