The burden of bailing out mortgage giants Freddie Mac and Fannie Mae will fall to taxpayers, predicted Brooklyn Law School Professor David Reiss, at a cost which the Cato Institute suggested could top $200 billion.
The Cato Institute hosted a lecture on October 19th called, “Which Way Forward for Fannie Mae and Freddie Mac?,” where economics and real estate savvy speakers discussed secondary mortgage markets and the government sponsored enterprises (GSE’s) Fannie Mae and Freddie Mac.
Subprime loans were, until recently, considered by the Mortgage Bankers Association (MBA) to be the main reason behind loan defaults and home foreclosures (The Los Angeles Times reported on October 14th that MBA says job losses are now the number one reason for foreclosures).
In a 2007 speech at the Federal Reserve Bank of Chicago’s Conference on Bank Structure and Competition, Federal Reserve Chairman Ben Bernanke addressed the role of secondary mortgage markets and GSE’s in sub-prime lending, a contributing factor to the “increases in subprime mortgage loan delinquencies and [the] number of homes entering foreclosure.” Subprime mortgages—loans made to high credit risk borrowers—really took off in the 1990’s, claimed Bernanke, saying that the growth of the secondary mortgage market has “permitted lenders to more easily sell mortgages to financial intermediaries, who in turn pool mortgages and sell the cash flows as structured securities.”
Fannie Mae and Freddie Mac were especially created by the federal government to encourage home ownership, David Reiss said at the lecture. Reiss, as a professor, concentrates on real estate finance and recently published an article called “Subprime Standardization: How Rating Agencies Allow Predatory Lending to Flourish in the Secondary Mortgage Market.” He further explained at the lecture that Fannie Mae and Freddie Mac were able to borrow money at low rates due to implicit government guarantees to protect their investments, causing them to sustain yearly growth and become, as Reiss put it, the “darling” of Wall Street.
Reiss blamed the 2007 third quarter losses—which ran into the billions of dollars—on “toxic exposure” to sub-prime lending and on the companies’ retaining too much of the government subsidies for management and for excessive profits.
Reiss, countering a contention that the companies should be nationalized or that they require merely a few more regulatory restrictions, argued that Fannie and Freddie should instead be privatized. He said the companies have shown “systemic risk” and do not create meaningful net benefits to taxpayers; although they were important in setting up secondary mortgage markets, they have “outgrown their origins,” he argued.
Privatization, Reiss warned, would necessitate that the government ensure regulation in order to maintain the consumer-friendly benefits which Freddie and Fannie had ensured. The government’s role, argued Reiss, is to protect against systemic risk, protect consumers, and provide affordable housing.
Jay Brinkmann, Chief Economist at the Mortgage Bankers Association (MBA), explained his association’s desire to split the two mortgage giants up and what the association sees as the government’s role in core secondary mortgage markets.
As part of the MBA-suggested framework changing the government’s role in secondary mortgage markets, Brinkmann argued that GSEs should be replaced with three private companies—MCGE’s (Mortgage Credit Guarantor Entities). According to a FairLoanRate.com September 3rd article, “government backup will be given to these new entities as well, but they would ultimately own the loans underlying the government-guaranteed securities they issue.” Brinkmann explained that these new structures would have the benefit of private equity behind them, would be subject to competition, have a sufficient number to spread risk, and would be chartered by a new federal regulator. A September MBA press release explained that
“The centerpiece of MBA’s recommendation is the creation of a new line of mortgage-backed securities (MBS). Each security would have two components— a loan level guarantee provided by privately-owned, government-chartered and regulated mortgage credit-guarantor entity (MCGE) and a security-level, federal government-guaranteed wrap.”
Thus, Brinkman suggests that there is room for limited government involvement, which is to ensure the factors that panelist David Crowe outlined: a stable flow of mortgage funds and liquidity.
David Crowe, Chief Economist at the National Association of Home Builders, claimed to be more on the side of the Brinkmann’s MBA than of Reiss and the private sector. Crowe argued that no private entity can guard against the overwhelming losses such as those seen in this recession. He thus argued that federal involvement is necessary in order to ensure the social benefits provided by homeownership, such as community engagement. However, he did make it clear that he was not arguing for nationalization of Fannie Mae and Freddie Mac, just that they should be market-driven.
The necessary components of secondary mortgage markets, stated Crowe, are to provide liquidity and stability and to lower mortgage rates, and so he argued that these markets need better supervision in the form of an effective and well-funded regulator whose oversight could prevent excess profits and inclusion of excessively risky mortgages in portfolios.
A September 2nd CNBC article quoted Joe Murin, former President of the Government National Mortgage Association (Ginnie Mae) as saying, “we are not going to have a robust housing market until we have a robust mortgage market, and the only way that is going to happen is to move away from what we have today…We do not want to nationalize Fannie and Freddie.”