In the July 21 edition of U.S. News & World Report, there was an interesting opinion piece written by Alan Reynolds, a senior fellow at the Cato Institute. Reynolds questioned the government-sponsored enterprise (GSE) setup relating to Fannie Mae and Freddie Mac. In keeping with the libertarian spirit of his organization, Reynolds wrote that the GSEs ‘need to be downsized and de-leveraged, relieved of special privileges and loan guarantees, and broken into small pieces agile enough to sink or swim on their own, without taxpayer support.’
Admittedly, Reynolds may be a voice in the wilderness – no one is currently rumbling in Washington to see Fannie and Freddie go private. However, it is a fascinating notion that deserves to be considered.
There is precedent for letting a GSE slip off to the private sector: Sallie Mae, created in 1972, completely severed its GSE ties in 2004. While the company has been through some rough patches as a private sector entity, at least it is not being pumped up with taxpayer funds to stay solvent.
Furthermore, the GSEs have seen more than their fair share of scandals and troubles during this past decade. The Office of Federal Housing Enterprise Oversight (OFHEO), to be blunt, never quite got a handle on keeping Fannie and Freddie in the realm of the well-behaved. Ironically, it is OFHEO that will probably disappear from the federal line-up once the pending ‘reform’ legislation becomes law.
Also, we need to be frank about the state of the federal deficit and the ability to pay for a rescue of the GSEs. At a time when Washington is hemorrhaging red ink, the very last thing the government should do is to throw billions of dollars at entities that are not functioning properly. Propping up Fannie and Freddie will cost at least $25 billion, according to the Congressional Budget Office.
If Fannie and Freddie were purely private sector entities, they would either need to clean up their respective acts ASAP or hammer wood planks across their front doors. When there's no safety net under your feet, either you learn to walk the tightrope correctly or you don't bother stepping out into the void.
Then there's the lack of evolutionary progress with how the GSEs function. In his U.S. News & World Report column, Reynolds did not mince words on how Fannie and Freddie are out of step with today's business world: ‘They're exempt from state and local taxes. And their required 'core capital' (mainly stock) is merely 2.5 percent of assets, compared with a 6 to 8 percent norm for banks. As a result, their $5.3 trillion of debt is piled precariously atop a thin cushion of only $81 billion in core capital.’
Considering the GSEs have spent more than $170 million in lobbying Congress over the past decade, according to the Wall Street Journal, you have to wonder whether they are serious about wanting to evolve.
The Wall Street Journal also reports that the GSEs' political action committees have already given $1.5 million in campaign contributions to Congressional representatives for the 2008 election cycle – which seems like odd behavior, all things considered.
Of course, there are GSE success stories. Ginnie Mae is clearly off in the right direction with its efforts to securitize reverse mortgages, and Farmer Mac has maintained drama-free operations ever since it was founded two decades ago. One might imagine that some pressure could be applied to force Fannie and Freddie to behave in a similar manner.
The situation is still playing out, and I doubt anyone can predict where or how the GSE crisis is going to unfold in the coming months. But should the possibility of privatizing Fannie and Freddie be put forward for debate? I am interested in hearing what people in the industry have to say. Please send me your thoughts and comments, and I will share your observations in an upcoming column.
– Phil Hall, editor, Secondary Marketing Executive.
(Please address all comments regarding this opinion column to hallp@sme-online.com.)
