The Obama administration sees the government continuing to play a role in housing finance by providing guarantees on payments to investors in mortgage-backed securities, but does not support resurrecting Fannie Mae and Freddie Mac in their previous form, Treasury Secretary Tim Geithner said today.
Speaking at a government-sponsored conference on housing finance, Geithner indicated there is no rush to shut down Fannie and Freddie, reiterating the administration’s previously stated intent to stand behind the companies while their investment portfolios are wound down.
Federal regulators and Fannie’s and Freddie’s new boards have raised underwriting standards and raised the fees the companies charge to provide guarantees, minimizing the risk that taxpayers will see the nearly $150 billion bill for bailing the companies out continue to grow, Geithner said in his prepared remarks.
Reforming the housing finance system "is about more than designing an elegant funeral for Fannie and Freddie," Geithner said. "It requires a broader reassessment of how much support the government should provide for housing finance."
Fannie and Freddie help money flow into mortgage lending in two ways: By guaranteeing payments on mortgage-backed securities (MBS) purchased by other investors, and by buying up mortgages and MBS to hold as investments themselves.
Fannie’s and Freddie’s MBS investments — including hundreds of billions of dollars in securities backed by subprime and alt-A loans — have been blamed for losses that led the government to place the companies under conservatorship in September 2008.
Geithner said the companies were allowed to build up "substantial portfolios" of MBS of all types, which rose to a level of more than $1.6 trillion dollars at their peak, "without the financial resources to cover potential losses."
But Geithner said Fannie and Freddie also joined the "general race to the bottom" across the private sector by lowering their underwriting standards and providing guarantees for increasingly risky types of mortgages, without charging enough to cover the risk.
"These two strategies were pursued to maximize short-term returns to shareholders and senior management," Geithner said. Fannie and Freddie, he said, "fought to take market share from private competitors while enjoying the privilege of government support."
The Obama administration, Geithner said, "will not support a return to the system where private gains are subsidized by taxpayer losses."
But Geithner said he still thinks there’s a "strong case to be made" for a "carefully designed guarantee in a reformed system" to provide stability in future economic downturns.
After the secondary market for private-label MBS broke down in August 2007, Fannie Mae, Freddie Mac and Ginnie Mae — the latter guarantees payments on MBS backed by loans insured by the Federal Housing Administration — became the primary conduits for channeling investment dollars into mortgage lending.
Today, Fannie, Freddie and Ginnie are involved in funding more than 90 percent of mortgages, and the "government’s footprint in the housing market needs to be smaller than it is today, Housing Secretary Shaun Donovan said in his prepared remarks at the conference.
"We need to work to foster a strong but healthy market for private capital — to harness the vitality, innovation and creativity in our system in a responsible way, so that consumers and communities gain real benefits without the race to the bottom that we have seen in recent years," Donovan said. "And that’s exactly what Wall Street Reform has done."
HR 4173, the Dodd-Frank Wall Street Reform and Consumer Protection Act, requires "very substantial changes to the securitization markets," to address issues that led to the crisis, Geithner said.
During the housing boom, there was a "fundamental breakdown in incentives around underwriting" as risk migrated away from banks to unregulated lenders, Geithner said. Many firms in the mortgage business were not required to hold capital against the risks they took, and credit ratings agencies did not adequately capture the risks of a significant fall in housing prices, he said.
While the Obama administration believes the financial reform bill has reduced the odds of another meltdown of the financial system in place, it wants to continue to provide some form of guarantees to MBS investors.
"The challenge is to make sure that any government guarantee is priced to cover the risk of losses, and structured to minimize taxpayer exposure," Geithner said.
Today’s conference was intended as a forum to gather input on what the government’s role should be. The Obama administration isn’t expected to unveil its plans for Fannie and Freddie until next year.
In the meantime, the planned wind-down of Fannie’s and Freddie’s investment portfolios "should be done in a careful way," Geithner said. The government needs "to make it absolutely clear that we will make sure the GSEs (government-sponsored entities) have the resources to meet their financial commitments."
In June, the Federal Housing Finance Agency ordered Fannie and Freddie to delist their stock from the New York Stock Exchange, but said the move was motivated by the fact shares in the companies were often trading below the minimum $1 average closing price, and not because any decision has been made about their future.
At the end of 2009, the Obama administration said the government was prepared to stand behind the companies for at least three more years. In the summer of 2009, the administration outlined six possible fates for Fannie and Freddie:
- Return them to their previous status as privately owned, government-chartered companies — an option Geithner ruled out today.
- Wind down Fannie’s and Freddie’s operations and liquidate their assets.
- Incorporate the GSEs functions into a federal agency like Ginnie Mae, which operates under the Department of Housing and Urban Development.
- Operate Fannie and Freddie on a public utility model, with the government regulating their profit margins.
- Convert the GSEs into companies that provide insurance for covered bonds.
- Break Fannie and Freddie up into many smaller companies.
The National Association of Realtors wants to see Fannie and Freddie keep their government charters, but not be shareholder owned. Subjecting the companies to "tighter regulations on product, revenue generation and usage, and retained portfolio practices" will ensure "they can accomplish their mission and protect the taxpayer," NAR maintains.
As government-chartered, but non-shareholder entities, Fannie and Freddie would have a separate legal identity from the federal government, but serve a public purpose — like the Tennessee Valley Administration, or the Export-Import Bank, NAR said in a position paper.
Unlike a federal agency, such organizations "enjoy considerable political independence and often are self-sustaining," not requiring appropriations from Congress, NAR said.