The Trump administration has an opportunity to break an eight-year-old logjam on mortgage finance policy and begin setting a future course for the government-sponsored enterprises, Fannie Mae and Freddie Mac.
Here’s how: Treasury Secretary Steven Mnuchin should request that Federal Housing Finance Agency Director Mel Watt suspend the GSEs’ regular payment of dividends to the Treasury, thus enabling the companies to replenish their reserve capital and putting the future of housing finance on better footing.
I have long been critical of policy changes that have undermined what should have been a relatively straightforward process on what to do with Fannie and Freddie. To be sure, their blurred mission and outsize footprint in the home loan market contributed to the 2008 financial crisis. However, partly as a result of reforms implemented since then, the companies have been profitable for years.
It is important to bear in mind why Fannie and Freddie do not retain quarterly profits. With concerns looming in the summer of 2008 about the housing market and the condition of the GSEs, Congress passed the Housing and Economic Recovery Act, or HERA, which created the FHFA. Shortly thereafter, the FHFA placed the companies in conservatorship. The Treasury received preferred stock, paying a quarterly dividend of 10% of the companies' profits, as well as warrants for 79% of the common stock. The government’s total investment has been estimated at $187 billion in capital.
Four years into the conservatorship, the Treasury Department unilaterally decided to amend the terms, moving to capture all of the companies’ profits in a “net worth sweep.” The government’s rationale was that this would protect taxpayers. The companies were said to be in a “death spiral” and diverting their profits to Treasury would ensure taxpayers would not have to pay for another bailout.
While Fannie and Freddie are government-chartered and the FHFA now largely calls all their shots, the GSEs are privately owned. Shareholders, rightfully angry over having their shares devalued, sued the government over the net worth sweep.
The sweep made a bad situation worse. We now have companies that back up more than $5 trillion in mortgage debt sitting in political limbo with zero capital.
Fortunately, there is a way out of this untenable situation. It starts with letting the companies rebuild their capital base. Two years ago, I pointed out that so long as the current arrangement persists, the taxpayers are more exposed than ever to another bailout. And recapitalizing the companies would not put them automatically on a path to returning — unchanged and unreformed — to their previous role in housing finance. If anything, it could enable the more desirable option of curtailing and clarifying their role.
Secondly, as I have long argued, it is imperative to restore the rule of law. HERA calls on the FHFA, as conservator, to take necessary steps to restore Fannie and Freddie to “sound and solvent condition.” Given that the GSEs have been operating profitably for nearly five years, it is hard to argue that they should continue to be held in conservatorship.
The Trump administration should reverse the legally dubious strategy it inherited from the Obama years. Periodically stripping the companies of their capital is directly counter to what HERA required. And leaving major financial institutions undercapitalized violates basic policy principles that go back to the Great Depression.
Furthermore, once the companies can be recapitalized, the task of reforming them will become less complicated.
The companies have repaid taxpayers more than $260 billion, compared with their $187.5 billion bailout, and changes have been adopted that are shifting more of their portfolios to the private sector. The administration and Congress should consider a public-private hybrid of Fannie and Freddie that moves them away from a nebulous government backstop.
Given the enormous countercyclical role Fannie and Freddie have long played in the mortgage market, policymakers will have to consider carefully a transition that would ensure there is enough capital in the private market to make up for the support Fannie and Freddie have provided. It is important to preserve access to homeownership at affordable levels. This can be accomplished without keeping Fannie and Freddie in place as they are.
After a long and unnecessary impasse, the conditions are finally right to work toward a new private-focused housing finance model that honors America’s tradition of promoting homeownership but spares taxpayers the responsibility of all liabilities and distortions in the housing finance market. By recapitalizing Fannie and Freddie, the Trump administration can unwind the fiasco that the conservatorship has become, restore the rule of law and create a new housing finance system that better serves all Americans.