Tuesday, January 25, 2011

A Solution for Fannie Mae and Freddie Mac?

The twin giants in the mortgage industry, Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) are back in the news.   While the Republicans are pushing to limit the government's role in the housing market, a long time Republican ally is urging caution.

The housing industry is clamoring to maintain some form of government guarantee for mortgages - to keep the housing market from weakening further.  See WSJ  1-25-2011, GOP Feels Heat on Loan Guarantees by Alan Zibel and Nick Timiroas (link to article - scroll all the way to the bottom).

A bit of history: Fannie Mae was founded in 1938 in the midst of the depression to prop up the housing market. Fannie Mae was set up as a government agency to buy mortgages from banks, repackage them as securities, and sell those securities with guarantees. In 1968, Fannie Mae was rechartered as a GSE (government sponsored enterprise) with stockholders as owners - but its securities were still guaranteed by the government. In 1970, Freddie Mac (another GSE) was created to provide competition for Fannie Mae.

On September 6, 2008, after years of encouraging risky mortgages (in response to pressure from Congress) Fannie Mae and Freddie Mac were in such bad shape they were taken over by the FHFA (Federal Housing Finance Agency). To help place this in the financial crisis time line, recall Lehman Brothers filed for Chapter 11 on September 15, 2008 (see very useful Financial Crisis Timeline St. Louis Fed).

The share price of common stock in Fannie Mac fell from a local high of $68.52 on 2-27-2006 to $5.10 on 9-5-2008 as the market priced in the possibility of a government takeover. Once trading resume after the takeover on 9-8-2008, the shares fell to $.98. On 1-24-2011, shares traded over the counter for $.493 .

In addition to the shareholders being essentially wiped out, the taxpayer is also on the hook. According to David Wessel (the Economics Editor of the WSJ) "The single most expensive cost to the tax payer in this crises will be Fannie Mae and Freddie Mac...estimated over 300 billion total" (see http://online.wsj.com/video-center?mod=WSJ_formfactor). Fannie Mae and Freddie Mac now guarantee about 2/3 of U.S. mortgages (see Alistair Barr video).  This means bankers still have limited incentives to make sure mortgages are only given to borrowers likely to repay.

Treasury Secretary Tim Geithner and others say that without some sort of government guarantee, the 30 year fixed rate mortgage would go the way of the dinosaur. In most countries, only variable interest rate mortgages are available - and often for shorter periods than 30 years. Without a government guarantee, mortgages would be harder to get and more expensive.  Construction jobs would stay scarce.

Two possible solutions:

1. a quasi public/private market solution (WSJ 8-13-2010, Alistair Barr from WSJ MarketWatch) (3 minutes)

2. a non-profit solution - Prof. Vogel states that the U.S. non-profit sector is bigger than GDP of Russia.
Prof. John Vogel of Tuck School of Business of  Dartmouth (1-19-2011) - (3 minutes)

If you want to get angry, here is a CBS clip (9-8-2008) about management problems at the GSE's right before they were taken over,

1 comment:

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