The Fannie-Freddie Dodge

Thursday, July 17, 2008

THE PARLOUS financial condition of Fannie Mae and Freddie Mac threatens the global economy. Treasury Secretary Henry M. Paulson Jr.'s request for standby authority to lend the mortgage giants more money and, if necessary, inject capital seeks to reduce this "systemic risk." Democratic leaders in Congress plan to attach the Fannie-Freddie rescue to housing legislation already passed by the Senate and slated for House consideration. Strangely, though, both the Senate and House versions of the bill potentially increase the very risks Mr. Paulson's plan is intended to mitigate.

Both measures would encourage Fannie Mae and Freddie Mac to buy bigger mortgages on the secondary market (which they would then either hold or sell as guaranteed securities to investors). Ordinarily, the government-sponsored enterprises (GSEs) buy high-quality loans under $417,000 for a single-family home. This "conforming" loan limit not only limits taxpayer risk, it also anchors the profit-hungry GSEs to their statutory mission: supporting affordable housing. Earlier this year, as clouds were already gathering over the GSEs, Congress raised the limit -- to almost $730,000 in certain high-cost areas -- on the theory that Fannie and Freddie could help unfreeze the housing market. The measure was supposed to be temporary. But the pending Senate and House bills impose permanent increases. The Senate would go up almost 50 percent, to $625,000. The House, led by Speaker Nancy Pelosi (D-Calif.), who represents the pricey San Francisco Bay Area, is considering a $730,000 cap. Either way, Congress would be authorizing the GSEs to pile more risk onto their already staggering balance sheets, and mostly for the benefit of buyers and sellers of expensive houses.

There's more. The core of both the Senate and House bills is a proposal to help subprime borrowers refinance into affordable government-backed loans -- provided that both they and their lenders absorb some losses. The plan could assist up to 400,000 homeowners over three years, at a cost of $1.7 billion, according to the Congressional Budget Office. Yet the Senate bill would fund the bailout through a fee on Fannie and Freddie, possibly $531 million in 2009, the CBO says. This is rather circuitous, given that government backing subsidizes Fannie and Freddie indirectly (and that they may soon be borrowing directly from the Treasury). And it contradicts the purpose of the mortgage bailout, which is to shore up housing prices: Fannie and Freddie will pass the fee along to their customers, thus decreasing housing liquidity and depressing the residential real estate market.

To be sure, the housing bills provide for a new, stronger regulator for the GSEs, which we support. That new regulator would presumably ensure that they raise enough capital to offset the costs and risks imposed by higher conforming loan limits and other new demands the bills would place on the GSEs. Yet the firms already need more regulation and more capital. Wouldn't it be simpler, and safer, to let a new regulator address their capital needs before plunging them ever deeper into the housing quagmire? Come to think of it, wouldn't it be wiser to revamp the whole GSE structure, rather than construct an increasingly elaborate apparatus to address -- or conceal -- the fact that it no longer works very well?

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