Fannie and Freddie Sit In Political Crosshairs

By Government SpendingFOXBusiness

It’s a scenario that could only play out in the surreal confines of contemporary Washington, D.C.

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The bailed out quasi-government housing agencies Fannie Mae and Freddie Mac have recently started generating sizable profits and funneling piles of money into the federal government’s coffers. So, naturally,  it’s time to wind them down and be rid of them once and for all.

That’s the plan, one of the very few plans circulating in Washington on which politicians of all stripes seem to agree.

The bipartisan hostility can be traced directly to the 2008 government rescue of the two housing entities that cost taxpayers $188 billion.

In a speech last week, President Obama summed up the widespread negative public sentiment toward Fannie Mae and Freddie Mac. The president said in effect that in the run-up to the 2008 financial crisis the giant mortgage finance companies played both sides of the fence, encouraging risky, high-interest-rate loans by lenders then profiting by buying up those loans. All the while Fannie and Freddie knew they were backed by taxpayers’ dollars should those loans fail, which many eventually did.

“It was ‘heads we win, tails you lose,’” Obama said.

The underlying principle behind the push to wind down Fannie and Freddie is to encourage more housing market participation by the private sector. The thought being that private lenders will be less likely to participate in risky lending practices if they have to cover their own losses.

“Whatever they do it has to be gradual so the market can adjust.”

Al Goldstein, CEO Pangea Properties

Surging Lending Costs?

The flip side of that argument holds that if private lenders take a larger role in mortgage financing the costs of mortgage lending will surge, making home loans less affordable and homeownership less accessible to middle and low-income Americans.

Mark Calabria, director of financial regulation studies at the Cato Institute, a libertarian research center, personally favors a swift death for Fannie and Freddie to reduce the chances of another 2008-like meltdown. “Let’s do a big bang because we can’t trust the political process,” he said.

Given the fickle nature of Washington politics, Calabria fears that the momentum to wind down Fannie and Freddie could fade as time moves on. Taking the political realities into account, he said it will likely take five to six years to phase the programs out.

One effective way to start the process, according to Calabria, would be to reduce the limits for what are known as conforming loans, or home loans that are eligible for purchase by Fannie and Freddie. The limit for a conforming loan in most areas of the country for a single family home is $417,000. That limit rises as high as $625,000 in more expensive regions.

Loans that exceed that amount, called jumbo loans, can’t be purchased by Fannie or Freddie and thus are not guaranteed by the U.S. government. They have to be originated and then securitized by private financial institutions.

Currently nearly nine out of ten loans originated in the U.S. fall into the conforming category and are guaranteed by the government, many after they are purchased by Fannie or Freddie.

Reducing the limit on conforming loans to, say, $325,000 for most home loans and $500,000 in high-cost regions would “shrink the amount of loans Fannie and Freddie could buy. It would give them a smaller share of the market as they are being phased out,” said Calabria.

Transferring Risk

By expanding the jumbo loan space it would increase the number of mortgages held as assets by private banks and transfer all risk of default to those private banks, he explained.

The current debate in Washington is over how large a role the government should play in housing financing after Fannie and Freddie are phased out.

A plan supported by Republicans in the House of Representatives would eliminate the government’s role altogether. Meanwhile a bipartisan plan percolating in the Senate would create a government entity, the Federal Mortgage Insurance Corporation, to regulate mortgages and serve as a backstop for banks against catastrophic losses.

“Whatever they do it has to be gradual so the market can adjust,” said Al Goldstein, chief executive of Pangea Properties, a multi-family real estate investment trust in Chicago.

Goldstein touched on an issue raised by those concerned that eliminating Fannie and Freddie will lift mortgage costs. Namely, that private lenders, tired of trying to assess the risks on long-term loans, might be inclined to rid the market of the 30-year mortgages so popular among borrowers because they stretch out payments and make loans more affordable.

“Thirty year mortgages would probably not exist without some guarantee,” Goldstein said.

Calabria disagrees that lending costs will rise if Fannie and Freddie disappear, replaced by profit-focused private lenders. “I think you’d see very little difference in pricing,” he said. Besides, Calabria added, interest rates are going to rise regardless of what happens to Fannie and Freddie, as the Federal Reserve scales back its economic stimulus programs.

Not everyone is convinced Fannie and Freddie should be wound down. Especially in light of the recent profits the two have generated.

Return to Profits

Last week Fannie Mae said it will make a $10.2 billion dividend payment in September to the U.S. Treasury toward its 2008 rescue aid. That’s in addition to nearly $60 billion Fannie returned to the government last quarter. After the September payment, Fannie will have paid about $105 billion to the Treasury, or about 90% of the $117.1 billion in bailout funds it received.

Meanwhile, Freddie Mac last week reported its second-largest profit ever, $5 billion, and said it will return $4.4 billion to the Treasury next month. That will bring the amount it’s refunded to about $41 billion, or almost 60% of the $71 billion it received in taxpayer bailout funds.

Winding down Fannie and Freddie just as they’ve returned to profitability makes no sense to Leif Thomsen, founder and chief executive of Walpole, Mass.-based home-loan lender Mortgage Master Inc.

“You’ve got two entities that are making money hand over fist and they want to shut them down,” Thomsen said. “But they’re politicians, not businessmen.”