David Hilzenrath, who covers Fannie Mae and Freddie Mac for the Washington Post, had a delightful anecdote in a recent article about HUD’s affordable housing regulations. He noted that in 2001 a $275,000 loan, secured by a $930,000 tudor style house on nearly two acres in Cincinnati, qualified as an affordable housing loan for Freddie Mac. This happened because the house was in a census tract that met HUD’s definition of an “underserved area,’’ and because the buyers put down $655,000 cash and didn’t need a jumbo mortgage.
Hilzenrath writes: “The stately Tudor may be an extreme example, but it illustrates the tensions inherent in a system that looks to two profit-driven companies to help low-income and minority home buyers.”
That, I believe, encapsulates the central problem associated with the very nature of government sponsored enterprises. They are expected to carry out one or more government missions, but there is an unavoidable conflict of interest between the fulfillment of that mission and their obligations, as shareholder-owned companies, to maximize profitability. In a very real sense they are serving two masters. The way that Fannie and Freddie treat their affordable housing obligations is a case study of this phenomenon.
In recent years, study after study has shown that Fannie Mae and Freddie Mac are failing to do even as much as banks and S&Ls in providing financing for affordable housing, including minority and low income housing. After studying the issue for years, HUD has finally proposed regulations that would tighten the definitions of such terms as “low and moderate income,” “underserved areas,” and “very low income families.” Then HUD set a goal that required Fannie and Freddie to devote increasing percentages of their total business to assisting families in the affected groups to become home owners.
On its face, the idea that Fannie and Freddie should be generous in support of minority and low income housing seems unexceptionable. A recent analysis by the Congressional Budget Office estimated the subsidy they received from the federal government--as a result of their implicit government backing--at around $20 billion. That would fund $100,000 mortgages for 200,000 minority and low income families. Why should the government provide any backing for Fannie and Freddie unless they were doing something that the market itself would not do?
But Fannie and Freddie don’t see it that way. They have complained that raising their obligations with respect to affordable housing could reduce their ability to finance middle class homes. In the political context in which statements of this kind are made, this is an important and serious charge--somewhat akin to threatening to close the Washington Monument if Park Service appropriations are cut. It is a signal that those who support the regulations may one day find that they will have to answer to an opponent who accuses them of supporting higher mortgage rates. To the financial community, however, the message is different. In speeches there, Franklin Raines says that the HUD regulations threaten to “change the nature of the company.” What this means is that if the regulations take effect Fannie will be less profitable.
Both approaches are designed to stimulate political support to prevent the erosion of profitability because of the greater financial risks that are associated with buying and holding or securitizing minority and low income housing.
But companies that are chartered by the government to perform a government mission should be devoted to achieving that mission. Tough regulations such as those HUD has proposed should not be necessary. The regulations are required because Fannie and Freddie--despite their advertising about such things as Fannie’s “trillion dollar commitment”--will not perform their mission voluntarily.
The resistance to the adoption of the regulations will be followed--if the regulations go into effect--by resistance to full compliance. HUD, if it remains in charge of this part of Fannie and Freddie’s activities, will have to spend considerable sums on monitoring and enforcement. The $993,000 tudor home in Cincinnati is only one example of the problems that will arise in the future.
In a June 2004 letter to the Office of Federal Housing Enterprise Oversight, commenting on OFHEO’s proposed corporate governance regulations, Ann M. Korologos, the chair of Fannie’s corporate governance committee, neatly outlined the essence of the conflict of interest that lies at the heart of Fannie and Freddie’s resistance to HUD’s regulations. Fannie’s directors, wrote Korologos,” are concerned that the [OFHEO] proposal’s focus on the federal charters and ‘public mission’ of the Enterprises may detract from our role as representatives of Fannie Mae’s shareholders. As directors, our duty is to act in the best interest of the shareholders.”
In the regulations we will be considering in this conference, HUD is making a valiant effort to bring the activities of Fannie and Freddie into alignment with their statutory mission and with their advertising claims. There is of course legitimate debate about whether the HUD regulations are well designed for their purpose, and that will be the focus of much of today’s discussion, but because of the completely legitimate position reflected in the Korologos letter it is doubtful that any set of regulations and any enforcement would be successful in driving these companies in a direction they do not want to go. That is the subtext of the discussion today.
If the government wants to assist low income families in becoming homeowners--a worthy goal for many reasons--it should do so through a government agency or through some other vehicle that does not have a directly conflicting agenda. The government will never succeed in attaining its ends through the use of companies that owe their principal loyalties to their shareholders, not to a government mission.
Peter J. Wallison is a resident fellow at AEI.
