Can we survive without Fannie and Freddie?

October 26, 2012 at 7:02 am Leave a comment

Should the government directly guarantee mortgage-backed securities?  That’s the most provocative aspect of a proposal put forward by Jim Millstein, who oversaw the restructuring of AIG at the Treasury when it was taken over by the government.   His views were given a great deal of coverage in Monday’s Wall Street Journal and if you believe, as I do, that sooner or later the government will have to grapple with what to do with Fannie and Freddie, he raises some interesting points to consider, even if you don’t drink all his Kool Aid, which I certainly don’t.

First, if you wave a magic wand and do away with Fannie and Freddie tomorrow, there would be no housing market in this country because there would be no financing.  The GSEs are involved with more than 90% of all new mortgages over the last four years.  What’s more, a decreasing number of banks hold onto their mortgages and right now the only places interested in buying these mortgages and packaging them into securities are Fannie and Freddie.  Remember that Fannie and Freddie charge the buyers of the mortgage-backed securities a guarantee fee against default, which means that your taxpayer dollars used to bail out Fannie and Freddie were actually being used to bail out bondholders.   Millstein proposes that Fannie and Freddie should no longer provide this guarantee and that it should instead be provided directly by the government.   He argues that the government already insures bank and credit union accounts, so why not provide the same protections against mortgage risks?

The second part of his plan would make a regulator responsible for assessing the quality of mortgages before they are securitized; again this sounds more radical than it actually is given how much the government has taken over housing policy.  The government has already decided that the CFPB should determine what constitutes a qualified mortgage eligible for greater legal protection.

Finally, Millstein would recapitalize Fannie and Freddie.  He argues that it is simply not realistic to think there would be adequate housing financing without these two behemoths and it’s possible that over time the American taxpayer can be repaid for the $141 billion worth of funds the GSEs have received.

Where would a plan like this leave credit unions?  The greatest fear of credit unions in a post Fannie and Freddie world is that a reduced marketplace for mortgage-backed securities will enable the largest financial institutions to effectively cherry pick the best mortgages the way health insurers cherry pick the healthiest clients.  In a worst-case scenario credit unions are left to charge more for riskier loans, making homeownership more expensive for their members and driving credit unions from mortgage lending.

I don’t totally buy this scenario but for those credit unions that don’t want to risk the unseen consequences of a truly free-market mortgage system, Millstein’s proposal provides a middle ground by ensuring that Fannie and Freddie will still be around to help provide liquidity for the secondary market.

FED Maintains Bond Buying Policy

In a statement released after a meeting of its Open Market Committee, the Federal Reserve announced that it is continuing its policy of buying long term bonds to keep down interest rates.  You can get the statement here.  Have a good weekend!

Entry filed under: Economy, Regulatory. Tags: , , , .

Untangling the SAMRT Prepare for the Worst, but Hope for the Best.

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Authored By:

Henry Meier, Esq., General Counsel, New York Credit Union Association.

The views Henry expresses are Henry’s alone and do not necessarily reflect the views of the Association.

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