Financial reform without Fannie and Freddie?
The Senate debate on a financial reform bill is not focused on the two mortgage giants whose risky loans contributed to the frenzy and near-collapse of Wall Street. Why put off a needed debate on the government's future role in pushing cheap home loans?
The Senate began debate Thursday on an overhaul of the financial-services industry. Conspicuously left out of the main bill are any big reforms of the housing finance system – whose roguish, risk-taking behavior was at the root of Wall Street’s near-meltdown.Skip to next paragraph
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In fact, the Obama administration wants to put off such reforms until home prices are stable, possibly next year. Another reason is that taxpayers are still bailing out the two biggest players in home finance, Fannie Mae and Freddie Mac, which repackage mortgages and resell them as securities.
The two giants were put into government conservatorship in 2008. Since then they have been the largest recipients of taxpayer dollars in a string of bailouts. They’ve eaten up close to $400 billion in rescue funds. And they still have taxpayers responsible for some $6-8 trillion (yes, trillion) in obligations. Five months ago, the Treasury Department had to announce that federal support for the two government-sponsored enterprises (or GSEs) would be open-ended for a long time.
Treasury Secretary Timothy Geithner says past problems with Fannie and Freddie were “symptomatic” of the regulatory failure of the financial industry. The two bought up subprime mortgages “without regard to the risk they posed to the system,” he told Congress last month. And they didn’t have enough capital cushion and were “inadequate” in their risk management.
Yet he and President Obama do not want reform of Fannie and Freddie in this Senate debate.
How can Wall Street itself be reformed without a Fannie-Freddie overhaul? The US mortgage market remains the second largest market for securities in global finance. The two GSEs represent nearly half of the residential mortgage market.
And even as Mr. Obama promises no repeat of the big bailouts of 2008-09, he’s still putting money into these big players.
As a presidential candidate, Obama was not in favor of keeping Fannie and Freddie in their role as market stabilizers for home loans with government backing. In fact, the Treasury Department has already outlined a different model for the two GSEs and has asked the public for ideas. But specific reforms are still secret.
Mr. Geithner did offer this in March: “After reform, the GSEs will not exist in the same form as they did in the past. Private gains will no longer be subsidized by public losses, capital and underwriting standards will be appropriate, consumer protection will be strengthened, and excessive risk taking will be restrained.”
The excuse of waiting on reform until home prices stabilize may not be the real reason for delay. Reform can happen even as the GSEs continue their mortgage work. The likely reason is that big political questions remain about how much government should still push the American dream of home ownership.
Will a revised Fannie and Freddie again be under pressure from Congress to go easy in providing credit to less-than-worthy home buyers? And will the two entities again recycle their profits into the campaign coffers of lawmakers who set policies for them?
Between 2000 and 2007, the portion of substandard home loans in the mortgage portfolios of the two GSEs went from near zero to 23 percent. This risky behavior to help the poor and middle class buy a home may have made sense at the time, as home prices had not fallen in a sustained way since the 1930s. But the near-collapse of Fannie and Freddie as home prices began to fall in 2006-2007 only revealed in hindsight that the two GSEs lie at the center of the US financial system.
If the two come up for reform soon, the guiding principle should be just what Geithner advises: “The mortgage finance system should not contribute to systemic risk or overly increase interconnectedness from the failure of any one institution.”