Why Obama Needs To Take Immediate Control Of Fannie Mae And Freddie Mac
When historians look back at this benighted moment in time, they may find themselves puzzled by how we refused to take the necessary steps to improve our economic situation. Depending on what happens in coming months, they may find that the best solutions—aggressive fiscal and monetary stimulus here in the United States, bank recapitalization and debt restructuring in the EU—were left on the table, while millions unnecessarily suffered.
A footnote in that history may be the decision of Fannie Mae and Freddie Mac not to do more to help the housing market recover. Faced with a flailing market and an alarming amount of underwater mortgages, Fannie and Freddie have nonetheless refrained from implementing bold plans to help out homeowners, citing their fiduciary duty to taxpayers as the reason. But by encouraging more refinancing and principal reductions of the mortgages these institutions either hold directly or insure, our government-sponsored housing giants could simultaneously improve both housing security and the overall economy.
At present, there are about 14 million underwater mortgages out there, with almost half of them more than 30 percent below sea-level, and most are insured or owned by Fan and Fred. Research has been very clear on this point: The most effective intervention to help these homeowners is to reduce their loan principal and bring what they owe more in line with what their home is now worth.
It’s no slam dunk—even with loan haircuts, some folks will still default. And there’s real moral hazard here: a legitimate fear that if people don’t face the economic consequences of buying too much house for their wallets, a lot more people will take that risk. But there are ways to diminish that risk, and the greater hazard isn’t moral, but economic: If Fannie and Freddie insist on staying out of the principal write-down business, the housing market will, at best, keep bumping along with hardly any growth for much longer than it needs to.
Of course, there’s a rationale for the behavior of these agencies: From their perspective, they’re protecting the taxpayer. Because of massive losses to their portfolio when the housing bubble burst, these two government sponsored enterprises (GSEs) became essentially wards of the state. That was a necessary move to keep the housing market from completely shutting down, as private banks got out of the mortgage business for a while (since the bust, the GSEs have originated or insured over 90 percent of new mortgages). But it also had a negative side effect. These agencies are independently regulated by the Federal Housing Finance Agency (FHFA). The regulator’s mandate is to protect the taxpayer from further losses and, as it sees it, any loan forgiveness is a direct hit on taxpayers. (I’ll elaborate in a moment how the mandate could be interpreted in ways that do get Fannie and Freddie into the refinancing and writedown business.)
But it’s not just the regulators: The GSEs are themselves complicit in the failure to get the housing market on more sustainable footing. Given how low mortgage rates are right now, we should be seeing twice the refinancing activity currently taking place across the country. But the only way banks will refinance mortgage loans right now is if the GSEs will backstop them, either through insurance or through buying bundles of the refinanced mortgages, packaged as MBS (mortgage-backed-securities). Having been burned before, however, the GSEs are now insisting on some protection against defaults: They’re either charging the banks a hefty fee or the right to “put back” the loan (i.e., sell it back to the originating bank) if it fails, or both.
Once again, the GSEs are ostensibly just protecting the taxpayer, but these protections are blocking a critical exit ramp from the recession. One mechanism that’s supposed to be helping the economy right now works through the Federal Reserve getting interest rates down—which they’ve done—and homebuyers responding with refinancing and new purchases. But the policies of the GSEs, motivated by the FHFA’s mandate to avoid losses and protect taxpayers, are blocking refinancing and therefore jamming the machine…