Fannie, Freddie and the Future of Housing
Three experts share their views on efforts to reform the mortgage giants, Fannie Mae and Freddie Mac, and why state and local governments should care.
Fannie Mae and Freddie Mac have been much in the news of late, and not in a good way. The two government-sponsored -- but investor-owned -- companies buy mortgages to free up lenders so they can lend again, bringing liquidity to the housing market. Between the two of them, Freddie and Fannie own or guarantee more than half of the $11 trillion of outstanding U.S. home mortgages. As a result of losses on those loans during the housing market implosion, they have needed $145 billion in taxpayer support to keep from going under.
In a few days, the U.S. Treasury Department will host a conference to kick off a proposal on how to reform Fannie Mae and Freddie Mac. State and local governments have an interest here -- not only in restoring a vibrant housing market but in the development of affordable housing, which gets preferential treatment from Freddie and Fannie.
To get a few views on efforts to reform the mortgage giants, I talked to three experts: Brooklyn Law School Professor David Reiss, whose expertise is in real estate finance and community development; San Diego State Professor Michael Lea, an authority on housing and mortgage finance; and economist David Ledford of the National Association of Home Builders. Their edited comments are below.
David Reiss spelled out the four broad positions regarding the future role of Fannie and Freddie in the housing market and took note of the perils within those options for state and local governments.
Fannie and Freddie are generally doing the job that they were designed to do, although their powers and that of their regulators should be tweaked.
DR: This is pretty much the status quo, but even that has impacts on localities. Fannie and Freddie purchased many subprime and Alt-A loans that had abusive terms for many borrowers. State and local governments have taken much interest in regulating such loans, although their efforts had been hindered by the preemption policies favored by the George W. Bush administration and by the strong arm tactics of Fannie and Freddie as well as the rating agencies.
Fannie and Freddie are generally doing their job, but are retaining too much of the value of the government guarantee for the benefit of shareholders and management at the expense of their affordable housing goals.
DR: This has the same risks as the first, but it also has the benefits of increasing affordable housing subsidies to state and local governments through the creation of an Affordable Housing Trust Fund or similar device.
Fannie and Freddie should be nationalized because the federal government has taken on most of the risk associated with them already.
DR: This reduces the risk of abusive behavior but will likely decrease innovation in the conforming loan market. There is not much state and local governments could do about it other than implementing their own mortgage programs through housing finance agencies that reach populations that a one-size-fits-all federal approach does not.
Fannie and Freddie pose a systemic risk to the financial system, unfairly benefit from their regulatory privilege and do not create net benefits for the American people. Therefore, they should be privatized.
DR: This has the benefit of increasing innovation, but also of increasing the incentives for engaging in abusive behavior in order to increase profits. If this is the path taken, it would need to be combined with assertive consumer protection regulation in order to get the benefits of privatization without the social costs of abusive lending. State and local governments (unless preempted by the federal government) would need to take an active role in promoting consumer protection in order to ensure that lending is done within their borders in a way that they find acceptable. That being said, a privatized Fannie and Freddie would have a lot of power to limit states' actions in this arena because of their extraordinary market share.
Michael Lea looked at the impact of real estate investments -- encouraged as they were by Freddie and Fannie.
The ease at which Fannie and Freddie allowed people access to credit at a low cost was a factor in the big real estate boom, and that boom was beneficial for local governments. They derived a lot of revenue from property taxes and jumped on the bandwagon by approving development and getting impact and other fees. That gig is up. Mortgage credit is going to be more costly and less available going forward. That's good from the standpoint of the broader economy, but perhaps not so good for state and local governments that rely on the real estate market as a vehicle to finance a lot of things.
An issue that will be addressed in reform debates is what to do about affordable housing goals. A lot of localities would like to see more affordable housing built. The preferential financing through Freddie and Fannie was one way to accomplish that. As private entities, they wouldn't have those goals. As a result, there would be less credit for affordable housing. If there is a perceived shortage of affordable housing, is there a way that would make more sense without having to have financing thru Freddie and Fannie?
Part of the problem we've had as a country is that we've put too much of our resources into real estate and not enough into high-tech and other infrastructure investments. I would say to state and local governments: Don't fight what might be a losing battle. Look to creating new jobs in clean energy, mass transit and other forms of investment. We want to build for the future with more sustainability than putting up the next subdivision.
David Ledford noted the alignment of interests by home builders and state and local governments in a reliable source of housing credit.
It's difficult to see how they can put Fannie Mae and Freddie Mac back the way they were with an implicit government guarantee. But we need that to insure there is a stable and adequate supply of credit for home buyers in the mortgage system. We'd like to see a parallel system where mortgages are originated by private banks, thrifts and mortgage companies, and sold to entities called conforming mortgage conduits (CMCs). They would purchase and sell the mortgages as securities, with a federal guarantee. The CMCs would pay premiums or fees into an insurance fund like the FDIC that would back those loans; they would be required to have substantial amounts of capital to support the activities they're undertaking. The government would only step in if there was a catastrophic situation.