Next Steps for Fannie and Freddie?

December 23, 2009

Next Steps for Fannie and Freddie?

The Financial Times yesterday today published a summary piece on what’s likely to happen next to Fannie Mae and Freddie Mac.  The Obama Administration has committed to laying out options in its February, 2010 budget submission.  But the folks responsible for producing them may rue this promise made earlier in 2009 when the rest of the Administration’s financial modernization package was unveiled.

The government’s unprecedented and aggressive support for the the mortgage markets hinges almost entirely on the continued role the two companies play in the market.  The private securitization market is dead.  Recent research from JP Morgan suggests that it will remain that way from some time to come.

The Federal Reserve’s $1.25 trillion purchase program for Fannie and Freddie MBS is supposed to wind down in the first quarter of 2010.  But many observers doubt they will be able to do so in the face of likely political opposition to moves that could raise interest rates for consumers, as phasing out the program might do.

The two companies also are playing a crucial role in administering the Administration’s Making Home Affordable” mortgage modification program.  Once restructured, it isn’t clear how that capacity could be easily replicated.

Perhaps because they were the first crippled financial patients to go under the knife in 2008, the terms of their government assistance are significantly more onerous than those that Bank of America and other major lenders had to agree to.  The dividend on the preferred stock held by Treasury in return for its investments in the two companies—now totaling $112 billion—is 10 percent, for instance, higher than that imposed on other bailees.  Neither company is likely to be able to pay back what they owe, in addition to their divident payments, anytime soon.

It can be argued that the government has the two companies exactly where it wants them:  firmly under government control, but not on the government’s balance sheet.  They can be used to further public policy goals without interference from shareholders or private owners, at a time when the government has few similarly powerful direct levers to work in the economy.

So the question essentially should come down to this:  what is the rush to alter the current structure?  With many trillions of outstanding MBS under their guarantee, and a combined market share exceeding 70 percent now, a great deal of the housing market’s immediate and near future health seems likely to ride on the two companies and the market’s faith in their guarantees on the securities.  And the only way to guarantee that for the moment, it seems, is through the continued support of the current system, however creaky it may be.  The Financial Times piece summarizes a series of potential paths the Administration could choose.  Having spent many hours over the last year with colleagues in the progressive policy sector trying to develop a workable successor model, I’m skeptical of their chances for success in the short run.  I look forward to working with them, and hope that something durable and workable can emerge.  But mostly I’m anxious that politics and theory are not allowed to trump pragmatism when it comes to the question of timing.  Rushing to a solution merely for the sake of having one is not the right path.