Introduction

Second Conference on the Privatization of the Housing GSEs

January 12, 2004

Peter J. Wallison

Resident Fellow, AEI

For those of you who did not see the Dow Jones dispatch on Friday, there’s a little news on the housing GSEs-or at least on Fannie Mae and Freddie Mac. According to Dawn Kopecki of Dow Jones Newswires, Fannie and Freddie have invited at least 75 Capitol Hill aides to ski at Deer Valley, Utah, next month-all expenses paid. I’m not joking. This junket is to follow a business and economic conference hosted by Senator Robert Bennett on the afternoon of February 19. Fannie Mae is picking up the travel and hotel costs for the entire 4 day, 3 night trip.

The dispatch does not say whether lift tickets are included, but since this gift is apparently permitted under the "education" exception, it may well be that ski lessons are also included. After all, vigorous outdoor activity extends peoples’ lives and enables them to pay their mortgages.

I don’t want to sound cynical-and maybe I’ve been in Washington too long-but what this says to me is that Fannie and Freddie are worried.

They should be. In the four years I have been working on GSE matters, I have never seen so much interest. Last week, even USA Today had an editorial that strongly implied support for privatization, and noted that the taxpayers were taking huge risks with Fannie and Freddie for very little apparent gain. And Bloomberg has assigned a veteran reporter full-time to the housing GSE beat. This is not yet a deathwatch, of course, but it shows an encouraging degree of interest in companies that used to fly happily under the media’s radar.

The current debate in Washington, and on the editorial pages, is not over whether regulation of Fannie and Freddie should be improved. That is a given. The key questions, as usual, are what agency should be the regulator, and what additional powers should it have that OFHEO doesn’t already have.

No one in Congress, as yet, is seriously questioning whether greater regulation is the right answer, but the AEI privatization project is based in part on the assumption that more regulation is not the solution to the Fannie and Freddie problem.

There are two factors that make the regulation of Fannie Mae and Freddie Mac different from the regulation of banks.

First, they are far more politically powerful. One of the reasons that Congress is not seriously considering privatization is that they don’t want to confront Fannie, Freddie and their massed chorus of supportive constituencies.

But if lawmakers give some more thought to this, they will see that a regulator is no more likely than Congress to make the tough decisions-such as increases in capital requirements or restricting the mission definition-that must be made in order to reduce the risks Fannie and Freddie are creating. The fact of their political power is all the more reason for Congress to doubt the efficacy of regulation.

Second, a serious problem at Fannie or Freddie could have a greater impact on the economy than a problem at any bank. Many doubt that a large bank would be allowed to fail in the United States, even though there are two dozen large banks, and thousands of smaller ones-and provisions of FDICIA, that attempt to reduce the likelihood of such bailouts. The reason large banks are considered too-big-to-fail is that such a failure could have effects on other banks and the financial system as a whole.

If that is true for a large bank, it is many times more true for Fannie and Freddie, which dominate the US residential real estate market and through that enormous market threaten harm to the whole US financial system.

And a serious problem at Fannie or Freddie cannot be ruled out. The gross misjudgments of Freddie’s management in manipulating the company’s accounts did not involve a weakening of Freddie’s financial condition, but there is no reason why the next mistake at either company will be so benign. The fact that OFHEO did not seem to know that Freddie was fiddling with its numbers only demonstrates that we cannot rely on regulators to protect us against major errors. In a real sense the economy and the taxpayers are hostage to the decisions of two managements.

For these reasons, more comprehensive regulation is not the answer. The only certain answer is cutting the ties between these two companies and the government, while making them smaller and subject to market discipline and market competition over time.

That’s what the plans we will discuss today are intended to do.

Over the short term, this might mean the loss of business for some of our fancier ski resorts, but it could protect them over the long run from having to pay a portion of a gigantic bailout.