Senate Forgoes Action on Fannie and Freddie For Now

Sam Chandan PhD FRICS Real Capital Analytics and the Wharton School The government-sponsored enterprises, Fannie Mae and Freddie Mac, reported their first quarter 2010 financials earlier this month. Fannie Mae reported a net loss of $11.5 billion in the first quarter; Freddie Mac, a loss of $6.7 billion. The bulk of these losses is associated with activities related to the GSEs' single-family housing mission and not their support for the multifamily sector. In fact, Fannie Mae reported a that its Housing and Community Development business segment, which encompasses its multifamily guaranty book of business, earned $99 million in the first quarter. At Freddie Mac, the 60 day delinquency rate on its multifamily mortgage portfolio remains just 0.24 percent. While the GSEs' multifamily portfolios have performed significantly better than the broader market, losses in their single-family lines of business dominate. To offset the resulting net worth deficits at Fannie and Freddie, the Federal Housing Finance Administration has now requested an additional $19.0 billion in Treasury financing for the GSEs. This investment, made under the terms of the senior preferred share agreement that came into effect with the September 2008 conservatorship, brings the total public investment in the GSEs to $145 billion. The 10 percent coupon on this investment requires that the GSEs now make annualized payments of $14.5 billion to the public purse. The sheer size of this obligation now precludes the GSEs' returning to profitability under their current structures. The announcement of the GSEs' first quarter losses and the new round of Treasury investment coincides with the broader financial reform debate in the Senate. And while the legislation introduced to the Senate floor by Chris Dodd does not directly address the long-term restructuring of the GSEs, members of the Senate have seized on the latest results in introducing related amendments. An amendment introduced by Republican Senators McCain, Shelby, and Greg would have mandated an end to conservatorship in two-years' time. This amendment was ultimately defeated, 43-56, in a May 11 vote. Coinciding with the defeat of the McCain bill, another, significantly weaker amendment was passed, 63-36, calling for further study rather than a specific course of action. Amendment 3739, introduced by Chris Dodd, requires only that recommendations be offered by the end of January 2011. The amendment requires that the "Secretary of the Treasury shall conduct a study of and develop recommendations regarding the options for ending the conservatorship ..." While the amendment calling for study falls short of real action, the Senate was right to defeat the McCain amendment. No doubt, delays in addressing the long-term structure of the GSEs and their mandates in the single-family and multifamily markets are problematic. Nonetheless, the magnitude and significance of these institutions preclude their being fully- and properly-addressed as a subset of the financial reform legislation. I had the opportunity to speak with GlobeSt's Erika Morphy about this very issue, and commented as follows: ... The Administration's proposal for restructuring of Fannie Mae and Freddie Mac was originally planned for February. The postponement of a formal plan has prolonged the uncertainty about the long-term structure of the residential finance system in the United States. It also extends uncertainties about the ultimate fate of the GSEs' multifamily finance roles.

The costs to the public purse that have followed conservatorship - in the form of senior preferred share investments in the GSEs - have kept the issue of GSE reform on the political and policy agendas. With the Treasury Department investing billions of public dollars each quarter to ensure the net asset value positions of Fannie and Freddie, it is understandable that many constituencies have grown frustrated and want to see the issue addressed now - conclusively - as part of the financial reform bill. But the restructuring of the American residential finance system is an enormous undertaking with global implications and must be addressed as a discreet issue. Fundamental questions regarding housing policy and market structure cannot and will not be addressed in an intelligent way as part of a two-week financial reform debate.

From an economic perspective, there is merit in many of the Republican proposal's conceptual underpinnings. For example, guarantees are less efficient than a clearly-defined and priced insurance mechanism. Guarantees also facilitate moral hazards and the potential for excessive risk-taking. On a more fundamental level, it is entirely unclear if there is a long-term role for government - either directly or indirectly - in broadly subsidizing the cost of mortgage credit in the modern US economy, distorting private market outcomes. If you believe that these questions deserve to be evaluated carefully and rationally and with gravitas, you should be skeptical of their being addressed as one more amendment in an Act that has already swelled to 1,400 pages ...