Fannie Mae (FNMA)

[10bambam]

Don't try to fix Fannie Mae and Freddie Mac. Phase them out instead
Author's email is included if anybody thinks it is worth it to set him straight.

Opinion: The Trump administration's reform plan wouldn't really reduce the federal government's role in the home lending market.

The United States could have a healthy housing market, if government would stop trying to help it out.

The Trump administration supposedly wants to reduce the federal government’s involvement in housing. But its recently revealed reform of Fannie Mae and Freddie Mac, known in wonk circles as government-sponsored enterprises, isn’t much of a step in that direction, if any at all.

The GSEs purchase mortgages, bundle them, and then sell the bundles as mortgage-backed securities. They guarantee payment on the mortgages to purchasers of the securities.

The privatization that wasn't

Fannie and Freddie began life as government agencies. They were supposedly spun-off and privatized. They obtained private stockholders

Government professed that they were stand-alone private entities. The market, however, assumed that the federal government actually was a backstop for the GSEs, that it wouldn’t let them go under in a crunch.

That turned out to be a safe assumption.

Because of the implicit backing of the federal government, the GSEs had a significant market advantage and dominated the MBS market.

They, however, began to lose market share as underwriting standards loosened in the housing bubble of the 2000s. To retain market share, and to respond to political pressure to do more for lower-income and higher-risk buyers, Fannie and Freddie loosened the underwriting standards for the mortgages they purchased.

Then the housing bubble burst. The federal government took the GSEs into conservatorship and, as the market had assumed, guaranteed their guarantees on mortgage-backed securities.

That was in 2008. They remain in conservatorship today, government agencies in all but name.

How Trump plans to reform that

The Trump administration wants to take them out of conservatorship and restore them as private corporations. But this time, rather than an implicit federal government backstop, there would be an explicit one.

The federal government would formally guarantee the guarantees Fannie and Freddie offer on their mortgage-backed securities. But the GSEs would have to maintain much larger capital reserves, so the crunch that would trigger a government bailout would have to be harder and deeper.

Moreover, the GSEs would have to pay in effect a premium for the government guarantee. And other issuers of mortgage-backed securities could apply for the same government backing under the same conditions.

Taxpayer risk would supposedly be reduced through the higher capital requirement. And premiums supposedly would pay in advance for any bailouts that might be required.  

Allowing other issuers of MBSs to obtain the same government backing supposedly would reduce market distortion and increase competition.

A better alternative: Phase them out

Overall, however, it’s hard to say that this represents a reduced role for the federal government in the housing finance market. Taxpayers ultimately guarantee more than 60% of mortgages in America today, between the GSEs and other government mortgage guarantee programs, principally Ginnie Mae and the Federal Housing Administration. Under the Trump administration’s proposal, that percentage is as likely to go up as down.

Regardless of how clean the guarantee arrangement starts out, it will inevitably be used as leverage to promote political goals. Politicians like loose underwriting standards for mortgages and preferences for favored political constituencies. And that’s how the housing market gets into trouble.

A group of free-market thinkers has devised an elegant alternative to truly reduce the role of the federal government. Simply reduce over time the size of the mortgages the GSEs purchase for securitization, until they disappear.

This would amount to a controlled experiment, to see if purely private securitizers would step up as the GSEs receded.

There is little reason to believe that they wouldn’t. People are still going to want to buy homes. With appropriate underwriting standards, mortgage-backed securities are safe long-term investments. There should be a robust market for them even without government guarantees.

The federal backstop to the GSEs is only one of numerous government distortions of the housing market, from the mortgage interest deduction to the Federal Reserve purchasing nearly $1.5 trillion in government-backed MBSs.  

Phasing out Fannie and Freddie, rather than attempting to rehabilitate them, would be a modest step in the right direction.

Reach Robb at [e-mail].

https://amp.azcentral.com/amp/2303413001