Fannie, Freddie, and the mortgage addiction

Since the mortgage market can't suddenly wean itself off government-supported Fannie Mae and Freddie Mac, some experts want more federal intervention. They're wrong.

Jason Reed/Reuters
William Gross, manager of the world's biggest bond fund at Pacific Investment Management Co. (PIMCO), told participants at the Obama administration's housing conference Aug. 17 that Fannie Mae and Freddie Mac should be melded into a giant federal mortgage guarantor.

In the first inning of what looks to be an intricate political game, the Obama administration and its financial industry allies suggested that the economy needs the federal government full force in the mortgage market.

The case was pithily made by bond honcho Bill Gross, who oversees more than $1 trillion of investments as head of giant bond shop PIMCO and was a speaker at the Treasury Department’s conference on the future of Fannie Mae and Freddie Mac.

“Having grown accustomed to a housing market aided and abetted by Uncle Sam, the habit cannot be broken by going cold turkey into the camp of private lending,” he wrote in a recap of his talk.

It’s an argument that is at once practical and yet nightmarish. Heroin dealer has his customers hooked. They can’t do without him. Therefore they will have to make sure he stays in business and continues ministering to their needs.

Government-created and -backed mortgage monsters own almost $5 trillion of debt. Mr. Gross asks: “how could private market advocates reasonably assume that pension, insurance, bank, and PIMCO-type monies would willingly add nearly $5 trillion of non-guaranteed, in many cases junk-rated mortgages to their portfolio?” Since they would not, “We are in a bind, folks.”

As a necessary solution, he proposes to fold Fannie, Freddie and other housing agencies into one giant federal office that will guarantee a majority of current and future mortgages. The idea is to move the $5 trillion to the federal budget and get taxpayers to fully support mortgage lending.

Privately originating and securitizing mortgages will carry a high cost, Mr. Gross says—private lenders will charge high interest rates and at those rates few people can afford homes.

We’re assured that taxpayers will be protected. Tight regulation will transform the heroin dealer into an upright, conscientious bureaucrat. Funny. Taxpayers are expected to guarantee loans at cheap rates and take high risks that no private lender will countenance. Yet somehow taxpayers are going to be alright. Regulation will suddenly become effective. Yet it failed for decades.

Encouraged by politicians – notably Barney Frank the financial reform showman – Fannie and Freddie pumped air into the real estate bubble. The collapse of the bubble caused the recession. The government spends our money to fuel the boom-bust cycle, then spends our money to reduce the pain of the bust. It’s the heroin dealer offering his hard-up customers credit to tide them over.

The only real solution is to say no to the addiction. You have to start modestly and slowly, but at least in the right direction.

Yes, the private market can’t absorb the gigantic $5 trillion debt. Not at once. The key is to sell the accumulated mortgages slowly, in small increments. This will take years— after all, it took decades for the government to create the mess. The objection that shutting down Fannie and Freddie will worsen the current property slump does not make sense. Setting up the process will take a long time. The real estate cycle will turn by then.

Mr. Gross is arguing his trade book, his protests to the contrary notwithstanding. PIMCO is a huge buyer of agency securities. Yes, privately issued securities have higher yields, but they’re not as plentiful. Having lots of paper available is advantageous for a buyer. He’s no doubt right that the market would be smaller if the government starts to withdraw. Without a subsidy, some people will not buy.

They’ll rent instead. That way, they won’t risk defaulting on mortgage payments. No easy doped-up credit to feed housing booms means less chance of busts. Is that a problem? It is to the federal subsidy pushers.

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