Nearly since the time Fannie Mae and Freddie Mac entered government conservatorship in 2008, some have called to release them back to the private market. At the same time though, there have been constant echoes that the GSEs need to remain countercyclical.
Playing a countercyclical role in the private market is simply infeasible, according to Don Layton, a senior industry fellow at Harvard University’s Joint Center for Housing Studies.
The former CEO of Freddie Mac called the notion that the GSEs could remain countercyclical post-conservatorship “quite wrong” and “fundamentally inconsistent” in a Joint Center blog post released Wednesday.
In short, he explained that “if a source of mortgage credit has private sector capital supporting it, it cannot truly be countercyclical. … Only the government—as the owner of the money printing press—can ignore market conditions.”
Without government backing, Fannie Mae and Freddie Mac will need to maintain substantive capital, just like other private financial firms, and they will need to adjust to market conditions—also just like other private financial entities.
To remain countercyclical, the government would either need to exempt the GSEs from capital requirements or provide capital itself as it did in the last financial crisis, Layton explained, adding “But do we really want to go through that again?”
“Perhaps it’s time to be realistic: countercyclicality is for FHA and VA, as direct government entities. Freddie Mac and Fannie Mae should be assumed neutral, at best, and more likely somewhat procyclical, just like the banks,” Layton stated.
“So we have a conundrum,” Layton said. The GSEs’ charter requires them to be countercyclical, but and end to conservatorship necessitates they become pro-cyclical.
Federal Housing Finance Agency (FHFA) Director Dr. Mark Calabria alluded to the delicate balance between maintaining appropriate levels of capital and risk while also fulfilling the statutory mission of keeping the market liquid when speaking before the National Association of Home Builders last month.
Calabria called capital “the foundation of safety and soundness regulation” and explained that the FHFA is “looking closely at the risk profiles of Fannie and Freddie to ensure they match their capital levels and support their statutory missions.”
The FHFA recently hired a financial advisor to help plan toward and end of GSE conservatorship.
Prior to their conservatorship, the GSEs did play a largely countercyclical role in the housing market due to their Congressional charters and large government subsidies, Layton pointed out.
However, in 2008, their ability to remain countercyclical with private sector capital came to an end.
“After all, how could they not be procyclical when facing massive losses and rapidly deteriorating capital ratios?” Layton said.
While the private-label securitization market, banks, and the GSEs must respond to economic cycles to remain viable, there are two entities that can and maintain a countercyclical role in the market: the Federal Housing Administration and the Veterans Administration.
“Their funding is directly on the books of the government, their securitization guarantees carry the full faith and credit of the government, and they have no equity holders or stock price to worry about,” Layton said. Thus, while other entities retracted during the financial crisis, FHA and VA market share grew from about 5% to about 20%.