Obama's Housing Policy Reform May Spare Fannie and Freddie

Anyone who hoped that taxpayers might be shielded from future losses will be sorely disappointed

600 fannie mae diag REUTERS Jason Reed.jpg

The government just can't seem to let go of Fannie and Freddie. Huge accounting scandals didn't deaden their impact. Gigantic taxpayer losses, at $170 billion and counting, haven't taught Washington its lesson either. According to a new report, the Obama administration is considering keeping the firms around, though their mission might change a little. Unfortunately, the possible role that the article's sources describe doesn't sound like very substantial housing finance policy reform.

Here's Zachary A. Goldfarb of the Washington Post with the scoop from his White House sources:

President Obama has directed a small team of advisers to develop a proposal that would keep the government playing a major role in the nation's mortgage market, extending a federal loan subsidy for most home buyers, according to people familiar with the matter.

The decision follows the advice of his senior economic and housing advisers, who favor maintaining the government's role as an insurer of mortgages for most borrowers. The approach could even preserve Fannie Mae and Freddie Mac, the mortgage finance giants owned by the government, although under different names and with significant new constraints, said people knowledgeable about the discussions.

If you connect the dots here, then the Obama administration's proposal begins to take shape. We are told that the government would insure most mortgages. Of the Treasury's three policy alternatives offered back in February, only one could apply. That was the "catastrophic guarantee" option, where government agencies would sell a guarantee on most mortgages to investors. Those investors would face some first loss percentage and pay a premium for the catastrophic guarantee that the government provides. If Fannie and Freddie are kept around, then presumably they would be involved in creating these guarantees.

There's a strange narrative being pushed by lobbyists in Washington that somehow if the government guarantees mortgages, we'll end up with a safer housing market than we experienced during the bubble. This view assumes a lot and forgets even more.

First, we can be pretty certain that Fannie and Freddie had no intention of going under due to their housing bubble strategy. Presumably, they had risk analysts who wrongly believed that they had enough capital on hand to cover losses that could result when the music stopped. Obviously, they miscalculated wildly. Now remember, Fannie and Freddie were for-profit firms that cared a lot about what investors thought. If they couldn't get the numbers right to provide safe guarantees, then are we really to believe that they would do any better if led by bureaucrats instead of investors?

Next, remember all of those mortgage losses faced by Fannie and Freddie? Last year I explained that about three-quarters of those losses were the result of guarantees gone bad. In other words, the most dangerous thing that Fannie and Freddie did was guarantee mortgages -- precisely what the government wants to do. Under the scenario described the government (read: taxpayers) would still be left with the bulk of catastrophic losses if another bubble were to arise.

But what about investors? Wouldn't they be more careful since they would take the first loss? Maybe, but banks and investors had plenty of mortgage exposure during the housing bubble -- and took massive losses. That is, after all, what caused the financial crisis: mortgage securities became toxic and the market seized. Bank and investor losses would be even smaller under this framework if limited to some finite first-loss piece. Would that really stop them from attempting to profit from an overheating housing market? Perhaps I'm just too cynical, but I don't see it.

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Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.

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