December 07, 2015
Gretchen Morgensen has an excellent piece in the NYT reporting on the revolving door between Wall Street banks and the Obama administration and the lobbying effort to dismantle Fannie Mae and Freddie Mac. These banks hope to be able to take over the business of the two mortgage giants with a system under which the government would guarantee 90 percent of the value of the mortgage backed securities they issued. While the piece does a very good job detailing the financial connections of the individuals behind this push, there are several important points which make the case against “reform” even stronger than presented in the piece.
To start, the piece tells readers:
“For all the problems associated with Fannie and Freddie, some housing experts say, allowing the nation’s largest banks to assume greater control of the mortgage market would most likely increase costs for borrowers.”
Actually, just about all housing experts agree that the privatized system would raise costs. Wall Street types get paid more than government employees and shareholders expect a profit. Therefore, we can be pretty safe in assuming a privatized system will have higher costs. The range of estimates in a Washington Post article from last year was that it would increase mortgage interest rates by between 0.5–2.0 percentage points. (I put myself near the bottom of that range.) If the roughly $6 trillion in mortgage debt on Fannie and Freddie’s books were all switched to this privatized system, the additional cost would be $30 billion a year, assuming the bottom end of this range. That is more than the federal government spends on the TANF program each year.
The piece also understates the risk that the proposed privatized system would pose to taxpayers compared to the current system. It quotes Jim Parrot, a consultant to the banking industry and former administration official:
“It [the current system with Fannie Mae and Freddie Mac] creates such a toxic mix of incentives where profit-seeking shareholders maximize risk and profit at the expense of taxpayers sitting there waiting to hold the bag if the thing goes south.”
This is actually not true. As long as Fannie Mae and Freddie Mac are in conservatorship, their profits go to the government, not private shareholders. This avoids the situation where they are shareholders who stand to profit by imposing risks on taxpayers.
In contrast, under the proposed reform, private banks could issue mortgage backed securities (MBS) of dubious quality and tell prospective investors that in the worst case scenario they would only lose 10 percent of their investment. This system would create exactly the sort of toxic mix that Mr. Parrot describes, where private banks would effectively be able to issue subprime MBS with 90 percent government backing. Given that they had little problem offloading subprime MBS in the bubble years with no government guarantee, this seems like a recipe designed to promote reckless lending.
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