So Where is GSE Reform Going, Anyway?
Jan/101
by Robert W. Zimmer
This Reuters article is the rare GSE journalist piece that calls it like it is. Let’s review the options laid out and see what’s what.
In religious wars, there are no innocent bystanders. This is certainly true for the multi-year tussle over the GSEs (Fannie Mae/FNM, Freddie Mac/FRE) and how they might fit or not fit in the US economic fabric going forward—and trust me, almost every journalist has an ax to grind one way or the other. In their heyday the GSEs were so big, so popular, and so powerful, that they swept skeptics and opponents out their way with ease—creating long-lasting enemies, including among the press.
Thus it is hard to find an unbiased viewpoint. Many journalists openly root for the GSE concept to fail and never raise its egotistical head again. Others take the contrarian view for sport. But finally there’s a piece that lays it out, with no agenda, and no ax. Let’s go over the Reuters piece in some detail.
Reuters: “That timeline (the unlimited backstop announced Dec 24) gives the Obama administration time to figure out what to do with the two entities since any changes are politically difficult and most analysts see the process taking years.”
Analysis: Dead on. The complexity of the secondary mortgage markets, combined with fear of yet-to-come exploding Option ARMS and weakening CRE markets, means there is no rush to “resolve” the GSE model legislatively. Washington policymakers want low interest rates and more modifications, and the conservatorship model is delivering them.
Reuters: “FULL NATIONALIZATION -This might be the easiest option and would return the companies to their origins as a government tool to nurture the housing market. Some analysts see the Obama administration’s Christmas eve move as a signal this is the direction they are leaning, but top White House economic adviser Lawrence Summers told the Wall Street Journal in late December “that certainly would not be the direction I would expect.” “
Analysis: Correct again. The “public option” didn’t work in the health care arena, and it won’t work here, especially as Republicans will undoubtably gain seats in the 2010 elections. And no one wants to further balloon the US budget deficit, which would happen if the GSEs were to be 100 percent nationalized. (Investors owning 20.1 percent of the companies, take heart! The US government can’t afford to take you out.)
Reuters: “PRIVATIZATION WITH PAYMENT FOR INSURANCE – Policy-makers might return the companies to investors and offer to insure Fannie Mae and Freddie Mac investments.
Washington could charge the companies a fee to underwrite their debt and some of their mortgage securities as a way to nurture the housing finance sector without standing squarely behind the companies. This idea, aired by Federal Reserve Chairman Ben Bernanke, would be akin to the Federal Deposit Insurance Corporation’s protection of banks.”
Analysis: Yes, an idea in play. This option recognizes that no one will ever believe going forward that the government wouldn’t step in again in times of debt market crises. So why not make the GSEs (and their shareholders) pay for the backing?
Reuters: “COOPERATIVES WITH LOOSE GOVERNMENT TIES – Fannie Mae and Freddie Mac could be run by the companies that sell them home loans. In such a cooperative arrangement, Fannie and Freddie would focus on long-term, stable business rather than maximizing profits. The federal government might still offer to insure the companies against the most catastrophic losses. This arrangement could be akin to the Federal Home Loan Bank system where a dozen regional lenders are jointly and severally liable for any one member’s losses and the federal government acts as guarantor of the entire system.”
Analysis: Dead wrong. The capital dedicated to cooperatives is not viewed as sufficiently flexible to support a dynamic mortgage market. More importantly, constituencies such as the Realtors and small bankers use the GSEs as a bulwark against the ever-larger, Federal-Reserve-leveraged, TARP-assisted Wall Street banks (does anyone believe THEY wouldn’t be bailed out again in a debt crisis?) that increasingly control the US mortgage market origination business—and these constituencies won’t tolerate the big banks controlling Freddie and Fannie via a coop model.
Reuters: “UTILITIES MODEL – Just like power and water companies that provide vital services, Fannie Mae and Freddie Mac could be run as private entities that have strong government oversight. The companies would aim to turn a profit and would have no government backing, but a conservative board would set earnings payments and customer fees.”
Analysis: Can’t rule this out. Stronger government oversight would have saved the GSEs from over-extending themselves in the bubble years, and a controlled ROE wouldn’t be the end of the world. And even guarantee fees could be subject to public rulemaking.
Reuters: “PRIVATE MORTGAGE-FINANCE COMPANIES – Although Fannie and Freddie are in government hands, their regulator is still trying to keep their shares trading. The agencies could emerge as large mortgage finance companies that bundle home loans for investors and raise funds in the traditional capital markets. Without government ties, though, the companies would not have lower funding costs and so would not enjoy the competitive advantage they do now. The federal government would also lose one of its most powerful tools for helping low-income home buyers. GAO said privatizing or terminating Fannie Mae and Freddie Mac would disperse mortgage lending and risk management through the private sector.”
Analysis: Not a chance. Full privatization would result in mortgage rates rising across the board by 50-100 basis points, and long-term, fixed-rate mortgages would be more difficult, if not impossible, to obtain. How many politicians want to get in front of THAT wagon? As for the GAO’s optimism of the private sector filling the space…really? Last time we checked, those guys checked out at the first sign of market instability. Anyone who has worked a day in finance knows that pure financiers are herd animals, which works well in most finance markets, but not the mortgage one.
Reuters: “COVERED BONDS – Covered bonds could become a mortgage finance tool to rival the influence of Fannie Mae and Freddie Mac. Unlike traditional mortgage-backed securities, which are frozen blocks of home loans, covered bonds allow banks to manage a dynamic pool of mortgages. This financing tool is popular in Europe but has a weak foothold in the United States because of regulatory constraints and the competitive advantages of Fannie Mae and Freddie Mac. The fate of those companies will have a direct impact on the future of covered bonds. “
Analysis: Covered bonds certainly have a place in the market going forward, but for reasons beyond the scope of this article, they can’t replace the securitization and retained portfolio model of the GSEs entirely. They will supplement, not replace, the function of the GSEs.
Conclusion: The Reuters piece is an excellent piece of reporting. With an overlay of basic political analysis, we can further narrow the scope of the ultimate options that will be debated by policymakers in Washington. And someday—believe it or not—the religious wars over the GSEs may actually reach an end. And we’ll all be better off for that ending.
Robert W. Zimmer is Principal at TVDC, a Washington-based financial services consulting firm.
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