Learning From Fannie and Freddie's Role in Foreclosuregate

Somehow the stories about the giant government-sponsored mortgage companies Fannie Mae and Freddie Mac ("F&F") just keep getting worse. On Thursday, Zachary A. Goldfarb and Ariana Eunjung Cha of the Washington Post reported that F&F helped to exacerbate the foreclosure crisis that began in the fall, often referred to as foreclosuregate. While you might think that government-affiliated firms would take great care to work only with servicers and law firms who would put homeowners' best interests first, you would be very mistaken.

Here's the gist of the WaPo piece:

Fannie and Freddie, the largest mortgage companies, shaped the practices being challenged in courtrooms around the country. They picked law firms that could foreclose fast and paid them based on how many foreclosures they could process. Speed was essential because delays cost the companies money - and, after they were taken over by the government two years ago, meant losses for taxpayers, too.

Not only did the companies urge swift foreclosures, but in at least one case Fannie executives also greenlighted working with a firm that they knew firsthand had engaged in legally questionable practices, according to documents and interviews with lawyers and industry officials.

And here's an example the article also provides of the aggressive policies F&F adopted to speed up foreclosures:

When law firms or servicers have taken too long to foreclose, Fannie and Freddie have threatened to charge them a penalty fee, according to industry sources and documents. And every few months, the two mortgage companies have sent servicers report cards ranking them on how rapidly they completed foreclosures compared with their peers.

There should be a few takeaways from this realization about how F&F viewed the foreclosure process. First and foremost, it demonstrates the problem with quasi-public mortgage companies like F&F. There's a clear internal conflict here. When F&F have their private firm, profit maximizing hats on, foreclosure speed is very important. From that standpoint, urging swiftness in processing foreclosures makes sense. But when F&F put their government charter hat on, they should be striving for the public good, delivering superior customer service.

Of course, when the government nationalized F&F in 2008, their internal conflict became even more complicated. No longer private firms, they were working to benefit taxpayers, which meant that increasing profit (or avoiding greater loss) was still a goal. But their public mission also became even more explicit as they were urged to help struggling homeowners modify their mortgages to avoid foreclosures.

Could F&F seek both of these ends simultaneously? There might be a way to find some middle ground between these two attitudes, but they would constantly be pulled in different directions. For example, if a homeowner is working to secure a modification and requests a two-week extension before foreclosure occurs, does F&F grant one? If it were just a bank, it would have no duty to do so. But as a pseudo-government entity, such a request might seem a reasonable way to assist a struggling taxpayer.

In regard to the sorts of shenanigans that F&F were encouraging according to the WaPo piece, however, even a private mortgage company should be censured. It's one thing to ignore customer service and put profits before people. Firms are perfectly within their right to adopt that strategy and let consumers decide their fate. But to knowingly work with firms that have legally questionable practices and to encourage cutting corners isn't even a legitimate strategy for a private firm to take. This shows that it isn't merely the private hat that has F&F acting inappropriately; the problem must be more deeply rooted in their culture.

From a housing policy standpoint, the WaPo story teaches us two things. First, it reinforces the theory that quasi-public mortgage companies are a bad idea. But further, it discourages the idea that F&F could be reformed. These firms are so screwed up, that they may be beyond help. It would probably be more productive to just get rid of these two GSEs and start from scratch. Even if you think that the government needs to have a role in the mortgage market, it shouldn't be through Fannie and Freddie.