By Bill Wilson – On March 29, House Republicans led by Conference Chairman Jeb Hensarling unveiled a piecemeal approach to bringing an end to government control of mortgage markets that includes winding down Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac. In 2008, Congress and the Bush Administration placed Fannie and Freddie into conservatorship as the firms descended into insolvency.
Since then, the government bailout has cost taxpayers more than $150 billion, with no clear exit strategy in sight for the government to reduce its footprint in the market. Over 90 percent of new mortgages are currently being backed by the GSEs and the Federal Housing Administration (FHA). This concerns House Republicans, who view government meddling in the market to have played a critical role in blowing up the housing bubble in the first place.
According to research by former chief credit officer of Fannie Mae and American Enterprise Institute Resident Fellow Edward Pinto, Fannie and Freddie held $1.835 trillion in higher-risk mortgages and mortgage-backed securities by 2008: $1.646 trillion, were GSE-issued mortgage-backed securities, and $189 billion of subprime and Alt-A private mortgage-backed securities.
Pinto recently published a forensic study explaining how government policies, including those of the GSEs, the Department of Housing and Urban Development (HUD), and the FHA helped to cause the crisis by weakening underwriting standards, lowering down payments, and generally degrading the quality of credit.
Also, because of the implicit backing of taxpayers, Pinto notes that the GSE-issued securities were automatically granted AAA bond ratings, and the GSEs were even able to misrepresent the quality of mortgages that underlined those securities.
As if that was not bad enough, Fannie and Freddie crafted a marketing plan that promised a higher rate of return than treasuries, but with the same risk associated with a taxpayer guarantee.
It was that implicit guarantee that enabled the GSEs to sell some $4.7 trillion of mortgage-backed securities, $1.5 trillion of which were sold overseas to investors, as reported by the New York Times. As more securities were sold, Fannie and Freddie bought more mortgages and bundled them into securities. As a direct result, Fannie and Freddie were able to acquire about half of all mortgages as of July 2008.
Coupled with easy money from the Federal Reserve, the housing bubble inflated as prices soared to unaffordable levels, leaving millions of Americans with mortgages they could not pay for after the economy collapsed.
The rest is history. Now, the housing bubble has popped, Fannie and Freddie (and thus most of housing finance) have been nationalized, foreclosures remain at record levels, private finance is still nearly non-existent, and the crisis has been papered over with $150 billion from taxpayers to the GSEs and another $1.25 trillion from the Federal Reserve to purchase a large swath of mortgage-backed securities from Fannie and Freddie. All that to put a floor under prices which plummeted anyway.
Now, the government is more invested in mortgage finance than ever. The Dodd-Frank financial takeover bill shielded the GSEs from any reform, with Senate Democrats even defeating an amendment to the bill by Senator John McCain that would have unwound Fannie and Freddie.
The comprehensive McCain approach was mirrored by Hensarling, and now has been broken into parts. Instead of one bill, there will be several, forcing up-or-down votes on critical items including unwinding the GSEs, repealing the firms’ federal affordable-housing goals, capping GSE employee pay, and increasing the fees that Fannie and Freddie charge to lenders for guaranteeing mortgage-backed securities.
These proposals are critical to restoring private finance of mortgage markets, ending bailouts, and removing the price distortions caused by government policies. Taken together, they will end the government conservatorship of GSEs in two years.
Then, the solvency of Fannie and Freddie would be evaluated by the Federal Housing Finance Administration, and if they proved to be insolvent, the GSEs would promptly be put into receivership. If the companies proved to be viable, then down payments on loans guaranteed by them would be incrementally increased over a period of three years from 5 percent to 10 percent.
Finally, the government charter would end after the third year of that period, bringing an end to the federal government’s dominance over housing finance — hopefully once and for all. The fact is, government helped wreck the mortgage markets with its foolish social policy to increase home ownership. In the aftermath, now it needs to finally get out of the way. The House Republican proposal is a good start.
Bill Wilson is the President of Americans for Limited Government.