Geithner Provides Philosophy, Not a Plan, on Fannie and Freddie

Today, housing finance was the subject of a hearing conducted by the House Financial Services Committee. Most of the discussion focused on Fannie Mae and Freddie Mac. Testifying first was Treasury Secretary Timothy Geithner. The Treasury has already made clear that it has no intention of offering a plan for fixing the government-sponsored mortgage entities (GSEs) this year. So, the two-and-a-half hours of testimony mostly consisted of Geithner providing some high level analysis and philosophical thoughts, instead of offering any tangible reforms for Fannie and Freddie.

His full testimony can be found here (.pdf). But the real fireworks began with the questions and answers. First, Democrats and Republicans bickered among themselves about whose fault it was that the GSEs had grown so out of control. The truth is that both parties are to blame. Anyone in Congress who wanted to shrink Fannie and Freddie was part of a small minority prior to the crisis.

When it came to questioning Geithner on the GSEs, the committee members seemed pretty underwhelmed with the answers he provided. A few wanted more specific plans of action for fixing the GSE problem, which the Treasury isn't ready to provide. This led to a few heated exchanges between Geithner and several representatives. The Treasury plans to collect information this year to determine what action should be taken. It will then present a plan for Fannie and Freddie sometime in 2011. Geithner maintains that it would be unwise to try to reform the GSEs prior to a full housing market recovery.

So what are some of those philosophical principles? Here's one that I find particularly important, from Geithner's testimony:

Avoidance of privatized gains funded by public losses. If there is government support provided, such as a guarantee, it should earn an appropriate return for taxpayers and ensure that private sector gains and profits do not come at the expense of public losses. Moreover, if government support is provided, the role and risks assumed must be clear and transparent to all market participants and the American people.

The key implication here likely has to do with the fact that Fannie and Freddie were private corporations with an implicit government guarantee. When they ran into trouble the government was forced to step in, to the tune of hundreds of billions of dollars. So you had a situation where the GSE's investors and executives were making a great deal of money at the ultimate cost of taxpayers. Let's hope that whatever the Treasury comes up with next year avoids this problem.

But I actually see this point as more broadly defined than this simplistic interpretation. The government has very much been in the businesses of propping up private business at the cost of taxpayers for decades -- even in times of economic prosperity. The bailouts during the financial crisis weren't unprecedented from a philosophical perspective as much as they were in their size and transparency. Whenever the government props up an industry, taxpayers foot the bill. And when it comes to housing, even if the government somehow manages to privatize the GSEs, it still will likely continue to prop up residential real estate in other ways. (More on this in my next post on the mortgage interest deduction.)