Fixing Fannie Mae
The Obama administration's necessary search for a new housing policy

Friday, August 7, 2009

WITH THE housing market possibly bottoming out, the Obama administration has begun to ponder the future of two institutions that have profoundly influenced U.S. residential real estate, for good and for ill: Fannie Mae and Freddie Mac. These government-sponsored enterprises (GSEs), which dominate the secondary market for home mortgages, have been under federal control since September, when mounting losses forced the Bush administration to take them over. The Treasury Department has pumped $85 billion of equity into the firms, and the Federal Reserve and the Treasury have bought more than $800 billion of their debt. This staved off the collapse of U.S. housing finance and a flight from GSE debt, which investors around the world had bought on the assumption that Washington stood behind it. But quasi-nationalization is not a permanent solution.

A final policy determination is probably months away. And the administration should spend time getting it right. The GSEs own or guarantee $5.5 trillion in U.S. mortgages; their $5.5 trillion debt, much of it held by the central banks of China and Japan, approaches the privately held debt of the whole federal government. One idea under discussion, as The Post's Zachary A. Goldfarb and David Cho reported Thursday, would be to break the firms into "good" and "bad" entities; the former would get a fresh start based on Fannie and Freddie's solid assets, and the latter would use government aid to wind down the toxic assets, including nonperforming loans and dodgy private-label securities.

So far, so good. But the tough question is what form the "good" entity would take. Before he headed President Obama's National Economic Council, Lawrence H. Summers advocated breaking the companies into pieces and selling them to the private sector. In a July 30 speech, James B. Lockhart III, the Fannie-Freddie regulator now returning to private life after contributing mightily to GSE reform, suggested letting a newly privatized secondary mortgage sector pay into a government-managed fund -- thus providing explicitly, and at a price, the backing that Fannie and Freddie once enjoyed implicitly and for free. Mr. Lockhart also urged that the mortgage companies be required to raise capital whenever housing price appreciation exceeds historic trends. That would both secure the companies financially and moderate the boom-bust cycle.

Whatever structure the Obama administration chooses, it must reject the old business model under which Fannie and Freddie pursued profit for private shareholders with funds borrowed cheaply based on a perceived government guarantee. Private benefit, public risk was a formula for disaster.

And the administration should rethink housing policy more broadly. The government "sponsored" Fannie and Freddie because expanding homeownership was, reasonably, deemed a public good: It fosters social and political stability. But in recent years, as the homeownership rate peaked near 70 percent, gains increasingly reflected the extension of credit to people who couldn't afford it. The rising homeownership rate proved not only unsustainable but -- as the current economic crisis has taught -- destabilizing.

A new University of Utah report suggests that homeownership will decline from the current rate of 67.4 percent to 63.5 percent in the next decade. In other words, we'll be back to 1985 levels. No doubt some will cite those figures to argue that government should once again pump up the mortgage market. But the policymakers in charge of redesigning Fannie and Freddie must stay focused on systemic risks. There can be as much, or more, dignity in renting a place you can afford as there is in buying one you can't. American society was pretty stable in 1985.

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