For some time, policymakers and industry executives have thrown around the idea of reforming and recapitalizing Fannie Mae and Freddie Mac, but is it possible at this point?
With every proposal for GSE reform being shot down at every turn, the chances of change occurring remains slim but not impossible.
Alex J. Pollock, Senior Fellow at the R Street Institute and former President and CEO of the Federal Home Loan Bank of Chicago, wrote in an essay released by the Urban Institute [1]Tuesday that the American housing finance sector is "as important politically as it is financially, which makes it hard to reform."
"More than seven years later, America is still unique in the world for centering its housing finance sector on Fannie and Freddie, even though they have equity capital that rounds to zero. Now they are primarily government-owned and entirely government-controlled housing finance operations, completely dependent on the taxpayers. Nobody likes this situation, but it already outlasted numerous reform proposals," Pollock explained.
In March, the Ninth Circuit Court of Appeals affirmed a district court’s decision [2] that Fannie Mae and Freddie Mac are private companies, albeit companies chartered or sponsored by the federal government, and not “officers, employees, or agents of the federal government for purposes of the False Claims Act.”
In upholding the lower court’s decision in the case of United States of America ex rel. Adams v. Aurora Loan Servs., Inc, the Ninth Circuit Court ruling stated that the FHFA’s conservatorship of the Enterprises does not “transform Fannie Mae and Freddie Mac into federal instrumentalities. We agree that the FHFA has ‘all the rights, titles, powers and privileges of’ Fannie Mae and Freddie Mac. However, this places FHFA in the shoes of Fannie Mae and Freddie Mac, and gives the FHFA their rights and duties, not the other way around.”
Pollock suggested seven ways to approach housing finance reform:
- Turn Fannie and Freddie into SIFIs at the “10 percent Moment”
- Enforce the law on Fannie and Freddie’s guarantee fees
- Encourage skin in the game from mortgage originators
- Form a new joint FHLB mortgage subsidiary
- Create countercyclical LTVs
- Reconsider local mutual self-help mortgage lenders
- Liquidate the Fed’s MBS portfolio
Yet another theory of why GSE reform may not be possible anytime soon is that Fannie Mae and Freddie Mac earnings are holding back recapitalization. Establishing enough capital with earnings would take decades, according to a recent report from the Wall Street Journal by John Carney [3].
"The question is likely to remain a theoretical one for the foreseeable future. The chances of the companies being released from conservatorship is extremely low," Carney wrote. "A far more probable outcome is that the companies eventually get wound down and replaced by a new system."
Carney continued, "This brings us full-circle, demonstrating that there is no realistic scenario under which the companies will be released from conservatorship in the foreseeable future. That leaves us with either a situation in which the conservatorships last in perpetuity or the companies get wound down and replaced with something new."