A year ago, my American Banker “Bold Banking Prediction for 2013” was: “The fate of Fannie and Freddie will be intensely debated but fundamental restructuring will not be achieved.” That was accurate, as it turned out. I added: “I will try to make myself wrong about this.” I did try, from a think tank angle. More importantly, so did scores of other people, many of them prominent, including Senators and Members of Congress, but reform did not happen.
Now for 2014, given the current situation, it is looking like the prediction should be similar: “The fate of Fannie and Freddie will continue to be debated, but fundamental structuring will once again not be achieved.” This prediction is buttressed by the installation of a member of the former political cheering section for Fannie and Freddie as head of their regulatory agency and de facto CEO of both.
The Congressional Fannie and Freddie reform agenda currently has two competing plans: Plan A is the House Financial Services Committee’s market-based reform bill, which should be enacted but won’t be. Plan B is the Senate bill, Corker-Warner or variations on it, which gives everybody something they want, including a fund to distribute off-budget subsidies and a new explicit government guarantee of mortgage-backed securities. It seems likely that neither bill can get through both houses.
We urgently need something done in the mean time to control Fannie and Freddie, now operating as a government monopoly, heavily subsidized by the Federal Reserve, and given passes on onerous regulation burdening everybody else, while they get ready to repeat their past egregious mistakes.
We need a Plan C—not another version of a grand bargain for housing finance, but a specifically targeted program to pre-empt the dangers of perpetuating Fannie and Freddie as favored, heavily subsidized, infinitely leveraged wards of the state.
I propose this Plan C with six steps:
- Formally designate Fannie and Freddie as “Systemically Important Financial Institutions” or “SIFIs,” as they obviously and undeniably are.
- Require Fannie and Freddie to have exactly the same capital requirements as SIFI banks do.
- As long as Fannie and Freddie have a government guarantee, make them explicitly pay the government for it in the same way as banks have to. I suggest a fee of 0.17% per year assessed on all their liabilities.
- Apply all the regulations to protect mortgage borrowers in full force to Fannie and Freddie, exactly as they apply to everybody else.
- Apply standard loan-to-one-borrower limits on Fannie and Freddie obligations held by banks.
- Set in statute the original 10% dividend on Fannie and Freddie’s senior preferred stock owned by the Treasury. After Fannie and Freddie pay the government for its guarantee, pay the 10% dividend, and are able to meet the standard SIFI capital requirement, then any excess capital must be used to retire the senior preferred stock at par. There must be no dividends on junior preferred or common stock until the taxpayers’ forced investment is redeemed in full.
Plan C will protect the housing finance system and the taxpayers for now, while the grand political bargain awaits a new Congress.
Alex J. Pollock is a resident fellow at AEI. He was President and CEO of the Federal Home Loan Bank of Chicago from 1991 to 2004.