NEW YORK (
) -- The fate of
is the most important national issue being avoided in Washington right now.
It's time for President Obama to push forward a serious discussion on the future of the two government sponsored enterprises -- which are wards of the state to the tune of roughly $185 billion and counting -- or the federal cash drain will continue to be a growing albatross on the U.S. economy for decades to come.
President Barack Obama
The two government sponsored enterprises, or GSEs, are still publicly traded companies, although both were placed under government conservatorship by their regulator, the Federal Housing Finance Agency, of FHFA, in September 2008.
While members of Congress enjoy using Fannie, Freddie and their regulator as pincushions to score cheap political points, they have let several years go by without a serious discussion on a way forward for the two mortgage giants.
Fannie and Freddie continue to hemorrhage cash, while increasing their government borrowings.
Fannie posted a third-quarter net loss of $5.1 billion
and borrowed an additional $7.8 billion from the U.S. Treasury, bringing the government's preferred stake in the company to $112.6 billion.
Freddie Reported a
, with additional government borrowings of $6.0 billion, to bring the government's preferred stake in the company to $72.2 billion.
The FHFA on Oct. 27 projected that at the end of 2014, "cumulative Treasury Draws (including dividends)," would "range from $220 billion to $311 billion."
In a letter to a group of senators following an outcry by Senator John McCain (R-Ariz.) over
$12.9 million in bonuses
paid to executives of Fannie Mae and Freddie Mac, FHFA Acting director Edward DeMarco said his agency was mandated by law "to rehabilitate the Enterprises as private firms," and explained that the executives of the two firms "are not public employees, and FHFA has used market compensation measures to target executive compensation at or below the median of comparable private sector positions at financial institutions roughly similar in size and/or complexity as the Enterprises."
DeMarco hopes to recoup some of the GSEs' losses. The regulator in September sued 17 large banks -- including
Bank of America
-- to demand full rescission and recovery of losses sustained by the GSEs from the purchase of nearly $200 billion in mortgage-backed securities from the banks.
The mortgage-backed securities sales to the government-sponsored mortgage giants by Bank of America -- including sales by Countrywide and Merrill Lynch before both companies were acquired by Bank of America -- totaled $57.5 billion, while the FHFA demanded rescission of $33 billion in securities sales by JPMorgan -- including those by Washington Mutual before the thrift failed and was sold by the Federal Deposit Insurance Corp. to JPMorgan in Sept. 2008.
For Citigroup, the mortgage-backed securities sales to Fannie and Freddie described in the FHFA lawsuit totaled $3.5 billion, while securities sales to the GSEs totaled $11.1 billion for Goldman, $10.6 billion for Morgan Stanley, and $3.5 billion for Citigroup.
Going the Citi Route?
President Obama and members of Congress seem to be hoping that over the long term, we'll return to a housing market being financed the way it was before the housing bubble burst. Apparently, the politicians hope that as home prices recover and the GSEs return to profitability, the government will be able to get its money back by converting its preferred stakes in Fannie and Freddie into common shares, and eventually selling those share in the open market.
This approach worked with Citigroup following that company's bailout through the Troubled Assets Relief Program, or TARP. The government is trying to use the same approach to recoup its extraordinary bailout of
American International Group
, but was sitting on 76.6% of AIG's common shares as of May 24, according to the most recent information available from
But with Fannie and Freddie running new deficits and increasing their government borrowings quarter after quarter, the companies' shares are stuck in a very low trading range. Shares of Fannie Mae were changing hands for 22 cents in midday trading on Tuesday, while Freddie Mac was trading for 21 cents a share.
Frank Mayer -- a partner in the Financial Services Practice Group of Pepper Hamilton LLP, in the firm's Philadelphia office - said that the traditional idea of financial institutions building leverage in order to finance home purchases and achieve a greater degree of homeownership, is inconsistent with "pressure from regulators for financial institutions to deleverage."
Mayer added that "Congress should focus on these policy issues, rather than reacting to existing contractual executive compensation issues," and that if the conflict between the two policy directions -- less leverage or more leverage for financial institutions -- isn't worked out, "there can't be a viable business plan for Fannie or Freddie."
"Nobody is going to buy stock in a company that doesn't have a clear path to success," he said.
The Future for U.S. Housing Finance
The United States is unique, in having a highly leveraged home financing system, with consumers mainly using fixed-rate mortgage loans to buy or refinance homes. Fannie and Freddie enhance the system's liquidity by purchasing a large portion of newly originated mortgage loans, and packaging them into securities. The GSEs provide underwriting and servicing guidelines to the lenders, while paying the original lenders or outside servicers to service the loans.
In addition to providing liquidity, Fannie and Freddie also do smaller banks the essential service of helping banks reduce their interest rate risk, since a portfolio of fixed-rate loans made during a period of low rates could be a major headache for a bank paying out higher rates on deposits during an inflationary period.
Without Fannie and Freddie, which together guarantee roughly half of outstanding U.S. residential mortgage loans, it is an open question as to whether the nation could continue with a primarily fixed-rate housing finance system of if we would have to move more toward adjustable rates.
Back in February, the Obama Administration presented a plan to Congress to "dramatically
transform the role of government in the housing market," that would limit the government's role to "robust oversight and consumer protection, targeted assistance for low- and moderate-income homeowners and renters, and carefully designed support for market stability and crisis response." Under the plan, the Administration would work with the FHFA to "responsibly reduce" the roles of Fannie and Freddie "in the mortgage market and, ultimately, wind down both institutions."
The Obama Administration's report to Congress also included three possible ways forward for the "long-term structure of housing finance," including:
- A privatized housing finance system, with "the government insurance role limited to FHA, USDA and Department of Veterans' Affairs' assistance for narrowly targeted groups of borrowers."
- A similar privatized system, but with a government "guarantee mechanism to scale up during times of crisis."
- A privatized system also featuring government "for the securities of a targeted range of mortgages."
Senator McCain a and Rep. Jeb Hensarling (R-Texas) in March reintroduced the GSE Bailout Elimination and Taxpayer Protection Act, which was meant to transition Fannie and Freddie back to being private companies, but eliminating the implied (and eventually realized) government-guarantee that enabled the GSEs to underprice "all private competition, creating a system in which they ultimately privatized their profits and socialized their losses."
The bill hasn't been brought to a vote in either the Senate or the House of Representatives.
So there you are. More than three years in, with nearly $185 billion in taxpayer money pumped into Fannie and Freddie so far, and with the largest sector of the U.S. economy at stake, some good ideas have been put forth on both sides of the political spectrum, but there is no serious public discussion about the future of the GSEs and the future shape of the housing market.
Written by Philip van Doorn in Jupiter, Fla.
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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.