Is Obama Playing a Shell Game with Housing?

Is Obama Playing a Shell Game with Housing?

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Barack Obama has finally started talking about Fannie Mae and Freddie Mac again, years after insisting that reforming the two mortgage giants would be a top priority.  But is the President serious about finally resolving the risk facing taxpayers, or is he just suggesting that Congress play a shell game with it?

It has been nearly five years since the collapse of the housing bubble in the US nearly caused financial systems across the globe to collapse, setting up fears of a run on the banks and the vaporization of trillions of dollars in capital.  A panicked Congress passed the first of two sweeping appropriations that Treasury used as a blank check to stopgap the American banking and financial sectors in October 2008.

Much of the funds went to bail out the government-sponsored enterprises, Fannie Mae and Freddie Mac, which between the two held over $5 trillion in mortgage securities that suddenly looked nearly worthless. The two GSEs were supposed to be financially independent of the federal government, but the bailout saddled taxpayers with huge losses from both.

To this day, that remains the case.  Taxpayers poured $154 billion into the two GSEs, and have only started to see a trickle of cash return recently.  Ever since the decision to conduct a taxpayer-funded rescue of Fannie and Freddie, politicians of both parties have demanded reforms that would either restrict their ability to rely on government subsidies or go entirely private to eliminate future risk to both the financial markets and to taxpayers.

Yet as we near the five-year mark of their rescue, the Obama administration and three successive sessions of Congress have done nothing whatsoever to deal with the risk posed by Fannie and Freddie.  The rational time for that effort would have come three years ago, when President Barack Obama and his fellow Democrats Barney Frank and Chris Dodd proposed sweeping legislative reform of the financial sector. 

The bill known as Dodd-Frank passed in the summer of 2010 and purported to put an end to “too big to fail” policies, but mostly imposed new fees and regulations on trading while doing nothing about either the two GSEs or the size of the financial institutions that required bailing out two years earlier. 

In fact, the bill created a mechanism whereby taxpayers would front the cash to unwind large-scale failures through the FDIC and wait up to five years to get repaid, legitimizing the 2008 actions ex post facto.  When asked why their bill failed to address either the GSEs or “too big to fail,” then Senator Chris Dodd admitted, “What we did … was fairly anemic in light of what we need to be doing.”

At the time, the White House claimed that overhauling the crippled GSEs would be a priority for 2011. Instead, they have remained silent on the failed entities, even while both Republicans and Democrats have repeatedly called for a resolution to the risk facing taxpayers – and a conclusion to the kind of government intervention that touched off the crisis in the first place. 

The lack of initiative has frustrated players in the lending markets such as Wells Fargo CEO Robert Kovacevich, who demanded action on the problem seven months ago.  “If it wasn’t for Fannie and Freddie, [the mortgage crisis] would have been a small problem. Fannie and Freddie and other government agencies guaranteed 70 percent of those [bad] mortgages,” Kovacevich told CNBC’s Squawk Box at the time. He warned that the public-private hybrid GSEs would create more mischief if left in place, and recommended instead that the Federal Housing Administration should take on any government role in home loans, where political manipulation of loan approvals had mainly been avoided.

After waiting years, President Obama returned to the Fannie and Freddie issue this week.  Appearing in Phoenix as part of his tour on economic policy, Obama called for the privatization of mortgage lending by winding down the crippled GSEs once and for all.

“First, private capital should take a bigger role in the mortgage market… I actually believe in the free market,” Obama told the press. “Private lending should be the backbone of the housing market."  He declared his support in concept for a bipartisan bill already moving in the Senate to unwind Fannie and Freddie, and urged Congress to find ways to strengthen the private markets to ensure broader but safer lending.

That the White House has finally taken some notice of the lingering wrecks of the 2008 collapse is encouraging.  However, Obama proposes to get rid of Fannie and Freddie while transferring the government’s ability to distort the mortgage markets to the FHA.  “We’ve got to keep housing affordable for first-time homebuyers,” Obama said, “[a]nd that means we've got to strengthen the FHA so it gives today’s families the same kind of chance it gave my grandparents to buy a home.”

The FHA began that process in 2009 as borrowers flocked to its doors after the GSEs went into government receivership, and the results are less than encouraging.  FHA’s former chief credit officer Edward Pinto wrote last November that the FHA’s capital position turned negative nearly overnight, and that the FHA itself might need its own taxpayer bailout.  The FY2012 actuarial study showed that the single-family program’s valuation dropped $23 billion in a year when the housing markets improved significantly, a serious red flag about the stability of its operation. 

“If it were a private company,” Pinto warned, “it would be shut down.”  Strengthening the FHA sounds suspiciously like a bailout to keep the path of intervention open in order to keep pursuing the kind of home-ownership political goals that shipwrecked Fannie and Freddie.

The Heritage Foundation raises another red flag on another part of the President’s proposal. Obama wants government to insure mortgage-backed securities (MBS) from home loans, funded by levying fees on investors.  The implication from this is that the guarantees would be self-funded, involving no taxpayer risk.  “But if a reinsurance guarantee is self-funding,” Heritage’s John Ligon and James Gattuso ask, “then why is the government needed?”

Surely that role should be filled by private-sector insurers who can compete on price and assess risk separately from political policies and agendas that have little to do with solvency--if the cost of the guarantees truly covers the costs of failures.  A government guarantee would ensure only that Washington retains its ability to distort the lending markets – and put taxpayers on the hook for failures in the MBS market just as it did with Fannie and Freddie. 

Anyone who believes that the revenue from the sale of guarantees would sit around in a lockbox to avoid taxpayer bailouts isn’t paying much attention to the Social Security fund.

Rather than simply swap Fannie and Freddie for the FHA and continue to have the government guarantee loans, we need to unwind the government’s ability to intervene in mortgage lending altogether.  Private lenders should assume the risks of their own investments, which should incentivize them to be more careful than they were in the last decade, when they assumed – correctly – that the federal government would take ownership of GSEs in a crisis. 

Government should regulate to prevent fraud, theft, and ensure proper levels of capitalization, a task that they haven’t been able to fulfill in their own operation at FHA.  The President has taken a good first step by putting Fannie and Freddie reform back on the table, but let’s produce real reform rather than a repeat of the same mistakes that created the crisis in the first place.