On Wednesday, the House Financial Services Committee’s Subcommittee on Capital Markets and Government-Sponsored Entities (GSEs), chaired by Scott Garrett, R-N.J., held a hearing titled “Fannie Mae and Freddie Mac: How Government Housing Policy Failed Homeowners and Taxpayers and Led to the Financial Crisis.”
The Democrats on the subcommittee immediately complained about the title of the hearing, and the debate went on in that vein, as have all hearings on GSE policies over the years.
This hearing featured a panel of mostly seasoned Democratic experts. The panelists were John Ligon, policy analyst at The Heritage Foundation, the identifiable conservative Republican; Joshua Rosner, managing director of investment research firm Graham Fisher & Co. and co-author New York Times Bestseller “Reckless Endangerment”; Susan Wachter, professor of real estate and finance at Wharton; and Lawrence White, an economics professor at New York University’s Stern School.
This article will touch on four issues discussed at the hearing: 1) the blame, 2) the implications of the blame, 3) proposals for reform and 4) observations and outlook.
1. Blame. The synthesis of the evidence regarding the blame is that under the Clinton and second Bush administrations, the GSEs were used to advance administration agendas.
The Clinton administration was influenced by two successive CEOs of Fannie Mae with close ties to the administration, Jim Johnson and Franklin Raines, to promise that the GSEs would enable an increase in the rate of home ownership from its historical rate of 65 percent to the neighborhood of 70 percent.
The George W. Bush administration continued to apply this pressure, with a somewhat different motivation, which was to exact a price for the government backing the GSEs enjoyed that might cause the GSEs to make a voluntary choice to downsize their activities so that the government could reduce its exposure. Instead, as might have been expected, the GSEs embraced the opportunity to expand their size as a means of justifying larger salaries and bonuses for their executives.
2. Implications. All of the panelists faulted both the private securitizers of mortgages and the GSEs for underpricing the risk entailed in packaging loans with risky features, such as low down payments and little or no documentation, for sale on the international securities markets based on top credit ratings bestowed by rating agencies. All of the parties involved received fees for their participation, even as they created a risk of huge losses, but they all assumed that house prices would continue to increase indefinitely.
When housing prices started to decline at the end of 2004, the conditions were in place for the bubble to burst and for the government to take over the GSEs and bail out the banks and securities firms that that financed the bubble.
3. Proposals. A number of proposals have been put into play. The most prominent are from a white paper the Treasury issued during the last Congress that purports to offer three choices, but obviously favors an option quite close to maintaining either Fannie Mae and Freddie Mac or a similar entity backed by the government.
In the meantime, the “too big to fail” bank Wells Fargo appears to have been designated as a national champion to join the cartel that dominates mortgage finance. Last week, the Bipartisan Policy Commission released a proposal that contemplates continued government support for the mortgage market. Also, a bill introduced in the last Congress by Reps. John Campbell, R-Calif., and Gary Peters, D-Mich., moderates in their respective parties, is one of many likely to be considered whenever Congress starts working on legislation.
Among the panelists, Ligon, who does not speak for The Heritage Foundation, recommended that the GSEs be wound down in order to protect taxpayers from further losses.
Rosner proposed a strict separation between private and public entities, with the private side led by a monoline insurer, along with full disclosure and solid documentation, so that the market would be able to price risk accurately.
Wachter warns that such a private insurer would be recognized as systemic and end up being backed by the government, so she acknowledged the inevitability of government support, but demanded transparency and strong regulation.
White also emphasized that long-term investors such as life insurance companies and pension funds, should take a larger role in the market, because they are funded by long-term investors, in contrast to the banks that have dominated this market with short-term funding and high leverage.
4. Conclusion. First, at a hearing just last week, the Senate Banking Committee considered whether any legislation to deal with the problems at the Federal Housing Administration (FHA) should be combined with legislation to restructure Fannie Mae and Freddie Mac, because the market shares of the three entities are co-dependent, but the panel responded that GSE reform is so remote, and the need to deal with the FHA so urgent, that Congress should take up the FHA first and separately.
Thus, the outlook is for the existing GSEs to be dusted off and re-entered into the fray, joined by Wells Fargo, and for business to go on as usual backed by an explicit government guarantee that the industry insists is necessary for private capital to come back to the housing finance market.
Ironically, the Federal Reserve, which under former Chairman Alan Greenspan sought to initiate a downsizing of the GSEs, would play a larger role as default purchaser of distressed mortgage securities.
Finally, a crucial question is the definition of the problem. As long as Democrats, led by Rep. Maxine Waters, D-Calif., define the issue as she did at the hearing — how to maintain the existing rate of home ownership and the traditional 30-year, fixed-rate mortgage with a free option to prepay — there will be no legislation. The current, dangerously flawed system will remain in place, with some cosmetic changes to mollify critics like the witnesses at this hearing.
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