Fisher Investments Editorial Staff
Politics, US Economy, Capitalism

Vaguely Reforming Their Fannie

By, 02/14/2011

Story Highlights:

  • Treasury Secretary Tim Geithner unveiled proposals to reform Fannie Mae and Freddie Mac.
  • Greater privatization of the mortgage market would reduce problematic government capital allocation.
  • While the talk is nice, at this point, it's vague discussion of a politically thorny issue.

Despite wide criticism for their role in exacerbating bad loan issuance and securitization—and running a tab of over $130 billion since their 2008 nationalization—Fannie Mae and Freddie Mac escaped relatively unscathed in last year's Dodd-Frank financial reform law. But at long last, Treasury Secretary Geithner unveiled the Obama administration's proposals for overhauling these two government-sponsored enterprises (GSEs) on Friday. The good news: Both the White House and Congress seemingly agree reforms are needed. And the bad news: The administration laid out three broad, vague plans for congressional debate.

Philosophically, we favor reforms to further privatize the mortgage market. Don't get us wrong: Fannie and Freddie's charter mission—attempt to make homeownership more broadly affordable—was noble enough. But the means to that end was (and is) problematic. When combined with other pieces of legislation, GSEs involved government too heavily in capital allocation—through implicit government guarantees on securitized mortgage debt.

Unlike banks and mortgage companies, government's direction of capital is often not based on weighing a debtor's risks against the reward of interest received. The economics of a loan is frequently outweighed by a desire to make political hay with certain voters. GSE-backing of mortgage debt tacitly encouraged banks to occasionally (or frequently) eschew risk, issue low-interest rate loans to sometimes less-than-stellar borrowers, securitize the debt, and sell it to investors with a (formerly implicit, now explicit since 2008) government guarantee. These incentives caused Fannie and Freddie's portfolio of guaranteed loans to surge in the last two decades. While GSEs in no way solely caused the financial panic (as we've frequently discussed), both the swollen GSE loan portfolios and the clumsy way the government dealt with the GSEs when troubled were contributing factors.

Most opponents of reform believe the heavy government involvement in housing finance is needed, claiming a privately dominated mortgage market won't work. But the jumbo-mortgage market has existed for decades with no GSE aid. And it usually functions just fine, thank you. It's true scaled-down government involvement in backing mortgages could increase some homeownership costs (i.e., interest rates and credit availability). But that remains to be seen.

But do the proposals actually privatize, anyway? Maybe. Here's the menu Geithner proposed:

Option 1: Government involvement in insuring mortgages would be limited to guaranteeing mortgages for creditworthy but low-income borrowers. (Mostly accomplished through the Federal Housing Administration and the Veterans Administration.)

Option 2: "Minimal" government involvement normally, only rising in times of "housing crisis." These broad terms leave a lot to the government's interpretation.

Option 3: The government retains involvement, but as a reinsurer backstopping private mortgage firms.

(Note: All three options' implementation would be long-term and gradual in an effort to avoid potential distortions.)

So while privatizing housing finance is in the political discourse now, the talk mostly fits the "TBD" category at this time. At this point, the government's vague recommendations with no timetable for passage seem most likely to generate blustery talk from pundits and politicians, not any giant, surprising, short-term negatives or great boosts for the economy. Right now, banking on the government largely exiting the mortgage business is a speculative bet at best. Housing is a thorny political issue to say the least, and politicians aren't paid based on sound economic decisions—the heart of the GSEs' problems in the first place.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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