With the overhaul of financial regulation in the bag, the Obama administration will focus next on housing finance with an eye to deciding the fate of mortgage finance titans Fannie Mae and Freddie Mac.
The administration said in a statement that it would hold a Conference on the Future of Housing Finance at the Treasury Department on Aug. 17. It will seek input for legislation to reform the rules governing mortgage finance and the markets for bonds backed by U.S. mortgages.
The Bush administration placed Fannie Mae and Freddie Mac in government conservatorship in September 2008. Uncertainty about what to do with them was ostensibly the reason most Republicans voted against the recent overhaul of financial regulations.
The White House pledged recently to send Congress legislation in January to revamp housing finance.
“The future of our housing finance system is critical not only to our economic recovery, but also to millions of American homeowners in every corner of our country,” said Treasury Secretary Timothy Geithner. “The Obama administration is committed to delivering a comprehensive reform proposal that protects taxpayers, institutes tough oversight, restores the long-term health of our housing market and strengthens our nation’s economic recovery.”
President Barack Obama has said he’d tackle Fannie and Freddie, which are both chartered by Congress, separately from Wall Street.
Fannie Mae was created in 1938 to boost homeownership after the Great Depression, while Freddie Mac was created in 1970 to provide more competition to Fannie Mae. The two congressionally chartered private entities traditionally buy mortgages originated by lenders and pool them into bonds backed by U.S. mortgages. This frees banks and other mortgage lenders from having to retain the loans on their books, and allows them to keep lending to home buyers.
Together, Fannie and Freddie guarantee about 31 million U.S. mortgages, collectively representing roughly $5 trillion in mortgage debt.
Early in this decade, Wall Street banks aggressively pushed their own secondary market for mortgage bonds, called private-label mortgage-backed securities. These banks captured significant market share from Fannie and Freddie, in part because lending standards eroded significantly and Wall Street entities had looser controls and fewer demands on mortgage originators than did the quasi-government entities.
Together the Wall Street banks, Fannie and Freddie supported a massive and ultimately unsustainable expansion in homeownership during the first half of the past decade. When the national housing market began to implode in 2006, reverberations shook housing finance to its core and led the government to seize Fannie and Freddie.
Big players in mortgage bonds on Wall Street, namely investment banks Bear Stearns and Lehman Brothers, collapsed in 2008. Investors in Fannie and Freddie mortgage bonds, once thought as safe as Treasury bonds, began clamoring for an explicit government guarantee. These financial instruments were always thought to be implicitly backed by the U.S. government.
Absent an explicit guarantee, investors began to shun this vital secondary market, which is needed for U.S. housing finance to function. Then-Treasury Secretary Henry Paulson concluded that if investors were to get such a guarantee, then Fannie and Freddie should be in government hands.
“Our economy and our markets will not recover until the bulk of this housing correction is behind us,” Paulson said on Sept. 7, 2008, announcing the historic government takeover. “Fannie Mae and Freddie Mac are critical to turning the corner on housing. Therefore, the primary mission of these enterprises now will be to proactively work to increase the availability of mortgage finance” for ordinary Americans.
At the time, Paulson said Fannie and Freddie would buy up even more mortgages in 2009, and then begin to shrink their portfolio of mortgage bonds by 10% a year beginning in 2010. However, because of the severity of the housing downturn, Fannie and Freddie are the only game in town—the only place for mortgage originators to unload their loans in order to keep lending to homeowners.
“Continuing to provide financial support to Fannie Mae and Freddie Mac was the right decision then for the mortgage market and for our economic recovery—and it has played a critical role in stabilizing the housing industry,” said Jeffrey Goldstein, Treasury undersecretary for domestic finance. “Fannie Mae, Freddie Mac and other government entities guarantee more than 90 percent of newly originated mortgages. They are practically the only game in town.”
Critics of Fannie and Freddie want the government eventually out of the mortgage finance business.
“At the end of this thing, there needs to be a private conforming mortgage market. It’s never existed,” said Alex J. Pollock, a scholar at the American Enterprise Institute, a conservative research group. He said that conventional mortgages given to safe borrowers should be pooled together by private firms. Fannie and Freddie’s advantage as quasi-government entities allowed them to bundle the safest loans that represented the brunt of the mortgage market.
Appearing recently on NBC, Geithner envisioned some government role at the end of the housing-finance overhaul process.
“I think we’re not going to preserve Fannie and Freddie in anything like their current form. We’re going to have to bring fundamental change to that market. But I think there’s going to be a good case for taking a look at preserving or putting in place a carefully designed guarantee so, again, homeowners have the ability to borrow to finance a home,” he said.
By Kevin G. Hall