Tuesday, March 8, 2011

What should we do with Freddie and Fannie

Fannie and Freddie cannot be dissolved any time in the near future.  They are sitting on probably a couple hundred billion dollars of losses (no one really knows for sure what the bill is, but it is enormous).  If they are dissolved in the next few years it is certainly the taxpayers who will be on the hook for that money.  If Fannie and Freddie continue to manage the existing problems and have the chance to make some money, over time,  they should be able to reduce that loss.  This is kicking the can down the road, but the alternative is politically impossible and there would be a LOT of finger pointing.

Long term -- the biggest single problem with Fannie and Freddie is that they operated like private-sector companies under the US Government umbrella.    Their executives  got to take home private sector wages and bonuses for taking risks that could be be socialized due to the implicit government backstop.     And because of that implicit government guarantee,   Fannie and Freddie also  faced political pressures from both the left and the right to meet what were essentially  “political” objectives such as expanding home ownership (no matter what the consequences), or facilitating the ability of Wall Street to make huge profits (no matter what the consequences).

Many people try to pin the blame on Fannie and Freddie for the 2008 crisis.  This is unfair.  The whole mortgage system was corrupt from the mortgage brokers who found ways to make bad borrowers look good, to the appraisers who helped to spiral UP home values, to the lenders who  severely loosened underwriting standards, to the rating agencies who did not act like trusted fiduciaries, and to Wall Street who ultimately benefited from this merry-go-round to package and sell a range of highly exotic and toxic investments.   The private market in this case failed miserably due to fraud, greed, a lack of accountability, and extremely poor regulatory oversight.  The left should not have pushed so hard for unqualified borrowers, and the right should not have pushed so hard for a failed deregulation of the industry.  And there were really no grown-ups running the show at Fannie and Freddie.

For many years, Fannie and Freddie performed a very critical role in creating an extremely viable and liquid mortgage market that greatly improved the availability of capital and lowered the cost of homeownership.  The American consumer benefited extremely well from this system and we were the envy of the world .  As private sector companies, though, the executives had real incentives to game the system over time to their advantage and this coincided nicely with the crazy fiscal and monetary policies at the turn of the century.

So what are the main alternatives?  Keep them as public –sector companies.   As 100% public-sector  companies, they will continue to face  political pressures to do the bidding of whichever party is in power.  Not good.

Make them totally private-sector?   The reality is that without some form of Gov’t involvement or guarantee, we would significantly prolong the recovery of the housing market and make home ownership prohibitively more expensive, more unaffordable and destroy another myth of the “American dream”.  Also not Good

So what is my suggestion?  First, let’s get Fannie and Freddie back to doing what they do best – as public-sector companies.  The Government’s backstop role is too important to abandon now and in the future.   We need to get the mortgage market functioning again and fast.  Second – let’s make sure that there is adult “oversight” of the mortgage system and processes.  That means ensuring that Fannie and Freddie can no longer be  a political football.

There is only one entity that I think has the skills and the ability to oversee and manage Fannie and Freddie in a responsible way -  The Federal Reserve.  Let’s make Fannie and Freddie subsidiaries of the Fed and thus under the Fed’s “umbrella” of independence and give the Fed clear supervisory  oversight.  The Fed has the ability to understand systemwide risks and the good sense to maintain credible and realistic underwriting standards.

Theodore B. Muftic
Chief Investment Officer
Invenio Capital

Ted Muftic is a contributor to The Muftic Forum and this blog. His biography and credentials can be found at http://www.mufticforum.com/
Invenio Capital is a capital investment firm in real estate

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