Rescue Us (Ballad of Fannie and Freddie)
Last week we witnessed a flurry of activity around the mortgage crisis. The President agreed to sign mortgage relief legislation in exchange for Congressional approval of a rescue plan for Fannie Mae and Freddie Mac. The good news is that Congress was able to leverage the Administration’s fears about Fannie and Freddie to get the President to sign the housing bill, including nearly $4 billion to rehabilitate vacant properties. The not-so-good news is that Congress is getting ready to hand the Administration a blank check for Fannie and Freddie.
Getting the President to back off of his threats to veto the housing bill is a big win for housing advocates, even if the bill has an air of ‘too little, too late’ about it. And, to be clear, Congress cannot stand by and allow the two largest mortgage companies to go under. Fannie and Freddie carry over $5 trillion in mortgage debt; they guarantee and/or own the mortgages on half of the homes in the US. Their collapse would be catastrophic: it would significantly raise the cost and restrict the availability of mortgage loans. Housing prices and sales would plummet; foreclosure rates would climb ever higher.
However, progressive analysts argue that Congress has a responsibility to insist on major changes in how Fannie and Freddie operate, including accountability from those whose decisions contributed to the panic, as well as significant regulatory reforms. In other words, the rescue plan they approved last week should have had strings attached.
If you are befuddled by what is happening with Fannie and Freddie, you are not alone. The behind-the-scenes deals that these companies make to leverage securities for mortgage loans are pretty convoluted, and the government's history with these firms is rarely discussed openly. As with many financial matters, however, the more people like you and me know about how we got into this mortgage mess, the better positioned we will be to help struggling homeowners and tenants, to push for more meaningful reforms of the banking and lending industries, and, to get more resources in our communities for affordable housing. So here’s a brief primer on Fannie and Freddie.
Fannie Mae, whose technical name is the Federal National Mortgage Association, was born in 1938 of New Deal parentage. When the national housing market collapsed during the Great Depression, private lenders were no longer willing to invest in home loans. Fannie Mae enabled local banks to get federal money to finance home mortgages. Federal financing made it possible for banks to make loans to low- and middle-income buyers who otherwise would have been considered too risky. (Note: It was not by the private market alone that so many of our families’ families moved into the middle class in the 1940s, 50s and 60s). Fannie Mae grew rapidly over those three decades. In 1968, President Johnson decided to take Fannie Mae's debt portfolio off the government balance sheet –– a quick way to make the national debt look smaller. Fannie Mae was converted into a publicly traded company owned by investors. In 1970, the government decided it was not good to have only one mortgage association, so they created Freddie Mac (aka the Federal Home Mortgage Corporation). This is how Fannie met Freddie.
These two privately owned giants are referred to as ‘government sponsored enterprises.’ (GSEs). Fannie and Freddie obtain funds from a variety of sources, such as pension funds, mutual funds and foreign governments. They back these securities with bundled mortgage loans.
Being GSEs means Fannie and Freddie also get access to a line of credit through the US Treasury, along with exemption from state and local income taxes, exemption from SEC oversight and ongoing assurances to investors that the government will never allow them to fail. Investors expect the Treasury to act as a lender of last resort, and this is why Fannie and Freddie have such an advantage over other lending companies.
Yet, as enterprises that are privately owned, Fannie and Freddie lobby for less government involvement in their operations. Since the mid 1980s, they have succeeded in getting the government to further reduce its oversight responsibilities. Even in the midst of the subprime mortgage crisis, Fannie Mae pushed for and won reduced oversight around their bookkeeping.
The collapse of the housing bubble has caught up with Fannie and Freddie. Too many prime mortgages are tied to properties with inflated prices. In a healthier market, lenders can recover most of their debt even if a borrower defaults, because the value of the house is close to the value of the mortgage. But, when foreclosure rates are high, and housing prices are down, good debt quickly goes bad. As more loans go bad on houses where the price was grossly inflated, the mortgage company has to bear the full loss, which can be as much as 50 percent.
Stockholders and lenders fear what falling housing prices may mean for Fannie and Freddie, which is why they started dumping their stocks during the week of July 7. By the end of that week, Fannie and Freddie stocks were down by 45 percent, causing major market jitters that even our usually laconic President could not ignore. It was a pretty dramatic market adjustment.
According to Dean Baker at the Center for Economic Policy Research, any rescue plan approved by Congress should hold management accountable for their bad decisions and poor stewardship (they promoted the housing bubble, for one thing), rein in executive pay and create reasonable standards for future lending. They might consider the notion that GSEs probably should be more accountable to the government that backs them. Better yet, Congress could insist that Fannie and Freddie become primarily public enterprises again.
Unfortunately, it appears that Congress will issue this Administration another blank check. I keep hearing Jon Stewart’s imitation of George Bush saying ‘when have I ever steered you wrong?’