Will Fannie and Freddie Be Broken Up?
September 2, 2009 by Miranda Marquit
Filed under Finance
Fannie Mae and Freddie Mac are two government sponsored entities (GSEs) that have been struggling lately. While private, the companies operate under a government mandate, and a de facto belief that the government is guaranteeing the loans it makes. However, Fannie and Freddie were not immune to the problems of subprime lending. With a little more confidence to take on risky loans, the two companies ended up with rather large exposure to loan defaults and ended up having to go into conservatorship.
After all of this went down about a year ago, there was a large amount of silence from the mortgage industry. Now, however, that silence has been broken. The Mortgage Bankers Association has offered a plan to break Fannie and Freddie up, and to require them to have a little more in the way of insurance to cover the loans the companies make.
While the MBA recognizes the role the U.S. government has to play in a housing market as large as ours, it also points out the risks of letting companies like Fannie and Freddie receive the benefits of implied federal guarantees to drive their business. Instead, reports The Street, a new way of doing things is proposed:
The firms would pay premiums into a federal insurance fund that would be used in case of default.
The guarantees would cover the credit risk and liquidity of each security, rather than interest-rate risk, implying higher coverage and premium prices. Interest-rate risk would be held by the security’s investor.
Fannie and Freddie would remain separate — and maybe be broken up into smaller companies — and be called mortgage credit-guarantor entities, rather than remaining GSEs.
The idea certainly has merit. It would force those running Fannie and Freddie to be a little more responsible with their decisions, and provide a framework for accountability when it comes to mortgage guarantees. Plus, the insurance fund would provide a way for losses to be covered, with out tapping taxpayers.
Let’s hope this happens. But the key issue is keep the new companies from becoming politicized and free of political interference so they can make sound financial decision instead of implementing policy preferences. If they aren’t independent we will have just created a bunch of baby Fannie and Freddies that will fall apart at some point in the future. I guess we are going to have to learn what an MCGE is.
I assume you mean solid decisions like Countrywide, Bank of America, Lehman and others made? ;) My main problem is that there were implicit promises of government guarantees that let Fannie and Freddie feel even more free to make poor decisions. Having some sort of system in place to help with reasonable homeownership is worthy, I think. No matter who’s in charge, when greed overcomes good sense, things start to fall apart.
You left out Merrill and Bear Stearns. However, I’d say BAC is more a victim of overpaying for questionable acquisitions of troubled firms. There’s no question that there’s corporate greed, especially on Wall Street and in the mortgage business, and these firms pay the ultimate price for excessive risk taking when the economy turns bad. But there’s also the greed of people trying to buy more house than they can afford, and their enablers in Congress who relax standards and do other tricks to increase home ownership, and the mortgage originators are more than happy to oblige, bend the rules as far as they can, and collect the fees. I’m all for home ownership; it’s a worthy goal. But I’m against rigging the game to allow people to buy more house than they can afford, no matter who does the rigging (and there is plenty of blame to go around). Giving people the ability to buy houses above their means does no one any good and leads to mess were are in now. I want to do mortgages straight up with no government distortions of the marketplace. That’s the point I was trying to make.
I definitely agree with you that reasonable homeownership, within borrowers’ means should be encouraged. There are many kinds of greed, and you are right that there is plenty of blame for our current mess to go around.