The government’s recent sale of stock in insurance giant American International Group is a welcome milestone in the unwinding of the massive federal investments made in private companies during the financial crisis. The bailout of AIG turned into a gain for the government, TARP investments in the biggest banks have been repaid at a profit, and the Treasury Department is selling off stakes in smaller institutions at an admirable pace. Taxpayers are being compensated for stabilizing the economy at a critical time.
Four years after the worst phase of the financial crisis, however, it is time to end the most costly bailout of all: the government takeover of Fannie Mae and Freddie Mac. Keeping the two housing-finance firms alive has been expensive. Treasury has invested $187 billion in the companies and has received $46 billionin dividends, for a net cost of $141 billion so far.
This support has allowed the two companies to continue to service the $4.5 trillion in guarantees against mortgage default and $900 billion in debt that they had racked up before the crisis, and to underwrite trillions of dollars in new mortgage credit. As a result, Americans have been able to get mortgages to buy homes and (especially) to refinance at lower interest rates.
But the firms shoulder an immense amount of risk, both by guaranteeing home loans against default and by owning them outright. This puts taxpayers on the hook for further losses and short-circuits the normal role of private investors in shaping housing and capital markets. Yet neither the administration nor Congress has a viable plan to end the government control of and exposure to Fannie and Freddie.
There is a way out that would protect the nascent housing recovery, revive the private mortgage marketplace and recover taxpayers’ investments in the firms. And the time to start is now.
Home prices have finally stabilized and are rising in many areas, and Fannie and Freddie are profitable again in their main line of business: bundling mortgages into securities and guaranteeing those securities against losses. This is the good news.
The bad news is that, four years after the takeover of Fannie and Freddie, the government now backstops 90 percent of all new mortgages and has no plan to reduce its market share, no plan to protect taxpayers against future losses on the trillions of dollars of mortgage credit underwritten since the firms were placed under government control and no plan to recover the taxpayer money invested in Fannie and Freddie. With the Troubled Assets Relief Program, the government worked with recipients to replace public investments with private capital as quickly as possible. Not so with Fannie and Freddie. Worse yet, two recent government actions threaten to make the companies permanent wards of the state.
First, Treasury decided to take all future earnings from Fannie and Freddie as a dividend on its outstanding investment. At first glance, that “cash sweep” seems laudable: Taxpayers should recover their investments in the companies before other shareholders recover a dime. The problem is that, if all earnings go to Treasury, the firms cannot use that money to build capital and reserves to protect taxpayers against potential losses. Private insurance companies hold capital against the risks they underwrite and build reserves to make good on future claims. If Fannie and Freddie don’t do so, it means that taxpayers will be on the hook for the firms’ losses for the remaining life of the 30-year mortgages they have written on the government’s watch.