Bolstering Fannie and Freddie
IF YOU THINK the credit markets are shaky now, imagine what would happen if either Fannie Mae or Freddie Mac -- or both -- defaulted. These two giant "government-sponsored enterprises" (GSEs) are in the vital business of guaranteeing mortgage-backed securities. And, as of the end of March, they had combined credit outstanding of $5.3 trillion, according to their regulator, the Office of Federal Housing Enterprise Oversight (OFHEO). This gargantuan amount of money is equal to the publicly held debt of the entire U.S. government. Fannie and Freddie are not, officially, government agencies; they are shareholder-owned. But they enjoy an implicit federal guarantee, which means that taxpayers would eventually be on the hook for any obligations they could not meet.
It will probably never come to that, but lately the prospect of a Fannie-Freddie default has become just a bit too thinkable for comfort. The housing bust is costing both entities billions of dollars in losses, yet Congress and the Bush administration are pushing them to provide more liquidity to the market. As they increase market share, they assume more and more of the overall risk posed by falling housing prices. Though both are raising fresh capital, their exposure to mortgages dwarfs their shareholders' equity. Each enterprise's core capital represents less than 2 percent of the sum of its mortgage assets plus guaranteed mortgage-backed securities, according to OFHEO.
We can't think of a housing-related policy objective more vital than ensuring the future stability of these behemoths. For too long, reform of the GSEs has been hostage to partisan politics in Congress. Yesterday, however, there was a breakthrough: The Senate Banking Committee adopted a bipartisan bill negotiated by committee Chairman Christopher J. Dodd (D-Conn.) and ranking Republican Sen. Richard C. Shelby (Ala.). The measure would create a new, unified and more independent regulator for the GSEs and 12 Federal Home Loan Bank Boards. Crucially, the new agency would have broad discretion to proactively increase minimum capital requirements for the GSEs. This would be a somewhat tougher regulatory regime than the House has recently approved -- and a dramatic improvement over current law, which lets the GSEs maintain reserves far lower than those maintained by other financial institutions. The thinner their cushion, the greater the risk to taxpayers.
The GSE reform measure comes attached to a mortgage bailout proposal similar to a $1.7 billion House plan about whose fairness and efficiency we have expressed doubts. The Senate version, though, is smaller and, its authors believe, significantly less expensive. It is funded not by taxpayer dollars but through revenue from a fee that is charged on Fannie and Freddie's transactions; the revenue previously was set aside for low-income housing. This mechanism raises fairness concerns, but it would be phased out over three years -- after which the money would go to rental units for the poor. Given the overriding importance of reforming the GSEs, the Senate bill represents an acceptable compromise.