WASHINGTON — With the overhaul of financial regulation in the bag, the Obama administration said last week it will focus next on housing finance - another key cause of the recent deep economic downturn - 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 change 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.
Fannie Mae, the Federal National Mortgage Association, was created in 1938 during the Great Depression to promote home ownership through purchases of mortgages insured by the Federal Housing Administration. In 1968, it was taken off the federal budget and made into a congressionally chartered private corporation owned by shareholders. In 1970, it was authorized to buy private mortgages.
Freddie Mac, the Federal Home Loan Mortgage Corp .,was created by Congress in 1970 to compete with Fannie Mae and foster a more robust secondary market. Fannie and Freddie both purchase mortgages from banks and other mortgage lenders, pooling the home loans for sale in a secondary mortgage market as a special bond, called a mortgage-backed security. This secondary market for loans means lenders don’t have to hold a loan on their books, freeing them up to do more lending to home buyers.
Together, Fannie and Freddie today guarantee about 31 million U.S. mortgages. Those mortgages represent a combined $5 trillion in mortgage debt. With the private sector impaired, Fannie and Freddie currently repurchase roughly 9 out of every 10 new mortgages.
The White House said last week it would 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,” Treasury Secretary Timothy Geithner said in a statement. “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.”
The announcement didn’t quiet critics.
“Better later than never,” said Alex J. Pollock, a scholar at the American Enterprise Institute, a conservative research group. “It is still my opinion that you cannot write a 2,300 page bill and not address Fannie and Freddie on the somewhat dubious excuse that it is too complicated.”
President Barack Obama had said he’d tackle Fannie and Freddie, which are both chartered by Congress, separately from making changes on Wall Street. He has been reluctant to make significant changes to Fannie and Freddie while the housing market remains weak and continues to slow the economic recovery. Existing home sales fell 5.1 percent in June and were expected to decline again in July. Most economic analysts now expect the housing market to bottom in 2011, five years after the crisis began.
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 marketshare 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.
As it turned out, the Wall Street banks, along with Fannie and Freddie, supported a large scale 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, under President George W. Bush, 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 percent a year beginning in 2010. However, the housing downturn has been so severe and the crisis in credit markets so deep that the private sector’s secondary market remains shut. That’s left Fannie and Freddie 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 during a period of crisis,” said Jeffrey Goldstein, Treasury undersecretary for domestic finance, in a White House blog last week). “Even today, private capital has not yet fully returned to this market. 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 Pollock, the American Enterprise Institute scholar. 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 July 25 on an NBC television news show, Geithner said he 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 even in a very difficult recession,” he said.
Business, Pages 65 on 08/01/2010