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Former President Donald Trump. Official White House Photo | Andrea Hanks
GSE “reform” is back on the table in Washington, if you can call it that.
The Trump administration, well known for its crusading, good-government zeal, is pushing to end direct government control of mortgage giants Fannie and Freddie Mac.
The major housing, banking and real estate groups are lining up behind the broad concept of “releasing” Fannie Mae and Freddie Mac into the wilds of the private market again, with the details still a work in progress.
However, the Trump plan is a big wet kiss for Wall Street, which can’t wait to recapitalize the two mortgage giants, but not so much for taxpayers who, whatever promises are made, will surely end up on the hook again someday should things go south.
How Did We Get Here?
The federal government took over Fannie Mae and Freddie Mac in the Great Recession amid the financial market panic caused by the meltdown of the subprime mortgage sector.
Fannie and Freddie backed or held roughly 65 percent of mortgages in 2008, and today retain a major role, though that number has dropped to 45 percent as competitors in the private sector have increased market share. However, the proposal sketched out by Trump’s housing and economic team is a return to the scene of the crime, opening the door not to reform, but rather to another government bailout down the line.
Before Uncle Sam rode to the rescue more than a decade ago, the two giant secondary market lenders had long enjoyed an “implicit guarantee” of an ultimate government bailout.
Basically, investors bet the feds would ride to the rescue if things got really bad, which turned out to be true. After all, the two giants either held or guaranteed more than half of the country’s mortgages.
The Trump administration wants to set a limit on how much the government will bail out Fannie and Freddie, but investors are likely to ignore this.
This allowed Fannie and Freddie to have their cake and eat it too – behave like a private company, engage in risky behavior and pile up mountains of mortgage debt, while not having to worry about the ultimate consequences.
Things are much simpler now under government “conservatorship.” Fannie and Freddie are under direct supervision, which at least limits the potential shenanigans, while their profits go to the U.S. Treasury.
By 2018, Fannie and Freddie had paid back the money the federal government pumped into their coffers during the bailout, and then some. All the while, Fannie and Freddie have continued to play their vital role of providing liquidity to the mortgage market, buying loans from banks and securitizing them.
This, in turn, enables banks to keep lending, writing far more mortgages than they would be able to otherwise were they forced to keep these loans on their books.
It’s not as perfect situation, but how often do you hear of a government operation that is actually turning a profit for taxpayers?
Trump Team Has Radical Plan in Mind
Trump’s team, in pushing for so-called privatization of Freddie and Fannie, contend they are effectively squelching competition in the secondary mortgage market. The statistics tell another story, with the private market now accounting for 55 percent of all mortgages securitized on the secondary market, with Fannie and Freddie down to 45 percent.
But the animosity runs much deeper.
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Fannie and Freddie, both outgrowths of the 1930s New Deal and 1960s Great Society reforms, were aimed at opening up homeownership to the middle and working classes.
Not surprisingly, as emblems of big government, they have also long been in the sights of Republicans in Congress, including Mick Mulvaney, a former Tea Party congressman who is now Trump’s chief of staff.
Trump, Mulvaney and crew are developing a plan that is likely to be far more radical than what the real estate and business communities are likely to back.
The Trump administration is pushing for a much more thorough and far-ranging, hard-right privatization, according to Fox Business News.
It’s not a great leap to surmise this version of privatization would likely jettison Freddie and Fannie’s current obligations to support affordable housing initiatives, which amount to many billions of dollars.
Proposal Makes New Bailout More Likely
In order to prevent another bailout down the line, Trump’s economic team has also talked about replacing the implicit government guarantee of the mortgages held and securitized by Fannie and Freddie with an “explicit” one.
That means Fannie and Freddie would not back any loans they don’t have the money on the books to actually back up.
Scott Van Voorhis
One of two things would happen here, neither great.
First, the new restriction could actually work. Fannie and Freddie would dramatically curtail their lending, shrinking the mortgage pool and making homeownership even harder and more expensive than it is now.
Or, more likely, investors will disregard the warning and continue to view Fannie and Freddie mortgages as enjoying an implicit government guarantee, with both GSEs too big for the federal government to ever allow to fail.
Either way, it’s fig leaf to obscure the fact that GSE reform is no reform at all, but rather a return to the old days when Fannie and Freddie were enjoying all the perks of a private enterprise with a big, fat government guarantee.
Better to keep things as they are than embark on a risky gamble that could backfire big time when the next housing crisis hits.
Scott Van Voorhis is Banker & Tradesman’s columnist; opinions expressed are his own. He may be reached at sbvanvoorhis@hotmail.com.
