"If the GSEs suffer a big loss and need to go back to taxpayers, there will be a political furor."

The Real Upside to Fannie and Freddie

Are Fannie Mae and Freddie Mac an antidote to the influence of big banks in the mortgage market, and, by extension, in the economy?

That’s what Bethany McLean thinks.

In her crisp examination of the two mortgage giants, Shaky Ground, the best-selling author lays out the risks posed by their current limbo-like state, a conservatorship they were put into by the government in September 2008 as their losses mounted amid the subprime mortgage implosion.

But she also recognizes the merits of keeping these government sponsored enterprises (GSEs)—two of the largest financial institutions in the world—alive.

The argument that Fannie and Freddie have value as big-bank buffers is a persuasive one. After all, a core rationale for bailing out banks during the financial crisis was that they were too big to fail; eliminating the GSEs would only allow the biggest banks to become even bigger.

There are, of course, other justifications for the GSEs: if they stopped buying loans from banks, mortgages would be less affordable and disparities in access to home financing—by region or socio-economic strata, for instance—would be more acute.  

Right now, though, Fannie and Freddie are in a state that many observers, McLean too, find untenable.

Since Aug. 17, 2012, they’ve been required to send all their profits to the government. Sure, it’s enabled them to pay off not only the $187.5 billion Treasury has injected into the GSEs since the conservatorship began but an additional $50.5 billion.

But that same rule has also left them sharply undercapitalized.

Even a “blip” in performance, McLean says, could send them back to taxpayers, hat in hand.  They are, in her words, “the last major institutions to remain in post-crisis uncertainty.”

McLean took some time to discuss the difficult terrain the GSEs are now navigating, the obstacles to reform, and how the continued viability of Fannie and Freddie is important if still very fraught.


ASR: Have there been any changes made to the housing finance system since the crisis that would prevent taxpayers from footing the bill for another collapse in housing prices?

McLean: In short, no. Government policy has actually been at best schizophrenic…While the administration has said repeatedly they want private capital in front of any taxpayer money that are exposed [to Fannie Mae and Freddie Mac] they’ve actually done a lot of things to discourage the private market from getting re-engaged in financing home mortgages and at the same time, they’ve done nothing to reform Fannie and Freddie.

Let’s talk about efforts to get private capital back into the market. One way the GSE’s are doing this is through risk-sharing. They have used various kinds of transactions to share the credit risk in mortgages that they insure with capital market investors, insurers and others. What’s your view on these?

It should be said that Fannie and Freddie’s regulator [the FHFA] and the companies themselves are doing a lot more to reform the housing market than anybody in the administration. There are pros and cons to that. This risk-sharing thing is real, they are definitely working to get people to take risk. But thus far, the problem with that is that [this market] could dry up. It isn’t a permanent structure and whenever there’ve been any wrinkles in the market, any blips, they’ve been unable to sell those deals. So it’s not really clear how sustainable or meaningful what they’ve done so far is.

We’re now the eighth year of the conservatorship. This wasn’t intended to be permanent.

I’m enough of a capitalist to believe that nationalizing the mortgage market is not the way to go. The idea of any administration having its thumb on the scale of mortgage credit is frightening to me. I want there to be some level of independence in that. I also don’t think the two companies can survive healthily in conservatorship forever. How would you feel if you were an employee who didn’t know if you were going to have a job in a year? And to listen to your company constantly be vilified? It’s not a healthy situation.

If substantial reform isn’t in the cards then what are the options here?