Public Utilities Numbers One and Two


Listening to the policy makers who will decide the fates of Fannie Mae and Freddie Mac brings home the reality of how far these once mighty pillars of residential real estate finance have fallen-and that they will never rise again to their former glory.  In fact, sometimes they get so much blame for the “systemic risk” that brought down mortgage-backed securities they sound like Public Enemies Numbers One and Two.

James Lockhart, administrator of the Federal Housing and Finance Agency, conservator of the two GSEs, outlined his options at a briefing for members of the National Association of Real Estate Editors last week. He talked first about the role the companies have played implement government policy-to reduce mortgage rates and to refinance and modify loans to avoid foreclosure. 

In November last year, the Fed announced it would purchase up to $500 billion in Fannie Mae, Freddie Mac, and Ginnie Mae Mortgage backed securities, and this was upped to $1.25 trillion in March. It has purchased $576 billion. In a second program, the Federal Reserve had originally announced a commitment to purchase up to $100 billion in Fannie Mae, Freddie Mac, and Federal Home Loan Bank debt. That was raised to $200 billion, and to date, the Federal Reserve has purchased $89 billion in Fannie, Freddie, and Federal Home Loan Bank notes. Lockhart credited the Federal Reserve support with keeping rates below five percent until lately.

Over the last three months, Fannie and Freddie have also done 1.8 million refinancings, of which 80,000 came under the new Making Home Affordable program, a quarter of which are over 80 percent loan-to-value ratio.

“Before deciding among the wide variety of possible legal and ownership structures for them, I believe the first decision is what we want the mortgage market to look like. Then we must establish some very basic principles that will guide evaluation of the options and the choice among them,” he said.

Lockhart outlined five principles that should guide the reconfiguration of Fannie and Freddie, points he made in his June 3 testimony before the House Financial Services Committee:

1. A well-defined mission based on their fundamental role in the mortgage market. Their mission activities should not require excessive risk taking. In other words, no more mission creep.

2. No more open-ended guarantees. Any federal risk-bearing should be provided explicitly. The old hybrid model of private, for-profit ownership underwritten by an implicit government guarantee allowed the Enterprises to become so leveraged that they posed a large systemic risk to the U.S. economy.

3. Any credit guarantees or mortgage insurance must be based on sound insurance principles: strong underwriting, strong capital positions, risk-based pricing, and flexibility to react to changes in the market.

4. A new regulatory structure that would never allow risk taking like allowing the GSEs to leverage their mortgage credit by well over 100 to 1.

5. Figure out a way to monitor, understand, and prevent or contain the buildup of excessive risk caused by imprudent practices related to housing finance, both the riskiness of individual institutions and the systemic risks.

Lockhart then outlined three structural options. The first is to nationalize Fannie and Freddie, which would incur a high level of risk for the Federal government. A second option is to keep the more or less as they are now-legally private entities under directs government control. A public utility mode could be established. A third alternative is to break Fannie and Freddie down into smaller purely private-sector firms to supply liquidity to mortgage markets with or without government catastrophic insurance or reinsurance.

Baby Fannie-lets and Freddie-lets also occupied the stream of consciousness briefing Rep Paul Kanjorski (D-PA) provided the same journalists the following day. Chair of the Financial Services Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, Kanjorski has immediate authority over the operation of Fannie and Freddie.

“Smaller entities can be allowed to fail,” he said, discussing the idea of creating private companies to securitize mortgages. The financial services reform legislation which will occupy his committee for the summer will include regulation of the GSEs, and it will include a “systemic risk regulator.”

Barney Frank, chair of the full Financial Services Committee, told the reporters there will be a mandate for the systemic risk regulator to have the ability to raise capital requirements in proportion to risk. “It may be the bigger you get the more capital will be necessary,” he said.

Frank came down on the side of the public utility model when he discussed the future options for Fannie and Freddie. Parts of their functions should be nationalized. Their divergent missions in affordable housing and securitizing mortgages should be separated out.  Does that make Fannie and Freddie Public Utilities One and Two?

Lockhart, in his talk to the reporters, said, “There is no shortage of ideas. I would venture to guess that everyone in this room has an opinion about what should happen to Fannie Mae and Freddie Mac. Congress and the Administration ultimately have to figure out the answer.”

However, the clock is ticking. Last week in yesterday’s financial reform agenda, it was announced that the Administration plans to have a proposal to reorganize the GSE’s when the President’s 2011 Federal budget is released in September.

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