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View related content: Housing Finance
While Congress has reached an agreement on the federal budget, consensus on housing policy continues to elude lawmakers. Despite lengthy and extensive efforts, there’s no agreement on how to reform the failed mortgage giants Fannie Mae and Freddie Mac.
There are currently two options. Plan A is the House Financial Services Committee’s bill, the PATH Act, a market-based reform that would phase out the government guarantee and these two government-sponsored behemoths. The hitch: No one thinks it can pass in this Congress. Plan B is the Senate’s Corker-Warner bill, which would wind down Fannie and Freddie but establish a new government guarantee for mortgage-backed securities.
What if neither bill can get through both houses? Then Fannie and Freddie will carry on the way they are: as mortgage-market-dominating wards of the state, run as part of the government, with no capital, entirely dependent on the Treasury Department’s credit card, while longtime political supporter Mel Watt runs the agency that regulates them. On top of that, the Federal Reserve buys and monetizes their mortgage-backed securities—so far to the tune of $1.5 trillion and continuing at $35 billion a month.
No private entity can compete with this setup. The status quo makes the politicization of Fannie and Freddie more likely and sets the stage for repeating past mistakes. While we await a broader reform of housing finance, I propose a Plan C with the following components.
First, designate Fannie and Freddie as SIFIs—”systemically important financial institutions.” Dodd-Frank gives the Financial Stability Oversight Council the authority to classify institutions that pose systemic risk to the economy as SIFIs, imposing additional regulatory requirements to protect taxpayers. It is undeniable that Fannie and Freddie pose great systemic risk. If the government refuses to take the obvious step of designating them as SIFIs, Congress should direct it to do so.
Fannie Mae already holds more assets than any other SIFI with $3.3 trillion on its books. J.P. Morgan comes in second with $2.5 trillion, followed by Bank of America at $2.1 trillion. Freddie Mac would take fourth place, holding $2 trillion. Designating Fannie and Freddie as SIFIs would put them in the category they belong—enormous players in the international financial system.
Second, require Fannie and Freddie to adhere to the same capital requirements as SIFI banks. Domestic and international regulators have laboriously analyzed how much capital an institution should hold to prevent government bailouts, and the same rules should apply to Fannie and Freddie. History makes clear that taxpayers need protection from the threat of Fannie and Freddie’s insolvency at least as much as they do from those of banks. The protection should include the Fed’s leverage capital requirement for systematically important banks—currently proposed at 5%.
Third, if we can’t get rid of Fannie and Freddie’s government guarantee, we can at least make them pay for it. All banks pay a deposit insurance premium—a fee to the government in exchange for a guarantee of their deposits. The fee is currently running at 0.17% of aggregate insured deposits per year. Fannie and Freddie have gotten a pass on paying for their government guarantee, but this should end. Congress should set an annual offset fee of 0.17%, payable to the Treasury, assessed on the liabilities of Fannie and Freddie which the government backs. That is, all of them.
Fourth, all of the regulations to protect mortgage borrowers should apply in full force to Fannie and Freddie. The Consumer Financial Protection Bureau has defined many requirements for mortgages with the goal of protecting borrowers. The qualified mortgage rule, for example, requires mortgage lenders to follow specific rules about assessing a borrower’s ability to repay a mortgage. The government waives these rules if the mortgages are sold to Fannie and Freddie. That is ridiculous.
Fifth, Congress should direct regulators to impose standard loan-to-one-borrower limits on any Fannie and Freddie obligation held by banks. Long-standing regulation prevents a bank from lending too much of its capital to any one borrower, but investments in Fannie and Freddie don’t count. During the housing bubble, the banking system was used to leverage Fannie and Freddie—regulations even encouraged banks to use deposits to buy preferred stock in Fannie and Freddie. This proved to be a big mistake that increased systemic risk and resulted in large losses to the banks involved.
Finally, Congress should set in statute the dividend on Fannie and Freddie’s senior preferred stock—the taxpayers’ $187 billion bailout—at the original 10%. The dividend rate is currently determined by political appointees at the Treasury and the Federal Housing Finance Agency. This authority belongs in Congress. After Fannie and Freddie meet capital requirements, pay the government for the privilege of having a guarantee, and pay the 10% dividends, then any excess capital should go toward retiring the taxpayers’ senior preferred stock. There must be no dividends on either junior preferred stock or common stock until the taxpayers’ forced investment is completely redeemed at par.
This Plan C is not intended as a solution to the problems of housing finance. It is meant to pre-empt the dangers posed by our pernicious and long-standing status quo, without waiting for Congress to reach a grand housing-reform bargain.
Mr. Pollock is a resident fellow at the American Enterprise Institute. He was president and CEO of the Federal Home Loan Bank of Chicago 1991-2004.
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