Fannie and Freddie Must Go

Wednesday, 18 Aug 2010 04:48 PM

By John Berlau

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After ramming through a “financial reform” bill that increases government controls on such ”ants” (hat tip to House Minority Leader John Boehner’s comments — distorted by the press — in full context) as orthodontists with installment plans and retail stores with layaway plans, but left the elephants Fannie Mae and Freddie Mac to roam free with unlimited taxpayer backing, the Obama administration finally held on Wednesday a promised summit to at least discuss putting some kind of fence around the government-sponsored enterprises.

But given the controlled atmosphere of the summit — which President Obama is not even attending, preferring instead to campaign on the West Coast — any fence this Obama administration will build will be very easy for the housing elephants to trample over.

Geithner set the tone of the summit Wednesday morning with what Fortune calls his “spilled milk” opening remarks attempting to deflect criticism of Fannie and Freddie’s losses. “There is nothing we can do to decrease the significant losses Fannie and Freddie incurred ahead of this crisis,” he said.

So far, the firms have taken $150 billion in taxpayer aid. The Treasury Department’s “Christmas bailout” of the GSEs — the Dec. 24 order removing the caps of $200 billion dollars that Treasury was authorized to spend on each of the two mortgage underwriters — exposes the American taxpayer to unlimited liability for the entities and their potential new missteps.

Competitive Enterprise Institute President Fred Smith had long warned about the systemic risk Fannie and Freddie posed to the financial system, warning as early as 2000 that their implosion could cause a taxpayer bailout of as much as $200 billion. Members of Congress expressed shock and outrage, but Smith turned out to have underestimated the ultimate costs.

And new research shows that rather than being “late to the subprime party,” as some press narratives had described it, Fannie and Freddie created and drove the subprime market as early as the ’90s. Indeed, according to housing expert Edward Pinto, Fannie’s former chief credit officer, who presented his findings before Congress and should himself be asked to testify before the commission, millions of mortgages to borrowers with credit scores of less than 660 (considered by prominent researchers to be the dividing line for subprime loans) had been labeled by Fannie and Freddie as prime, going back as early as 1993.

In his writings for the American Enterprise Institute, Peter Wallison, now also a commissioner on the Congress-created Financial Crisis Inquiry Commission, noted that this misrepresentation by the government-backed mortgage giants could have itself been a major factor in inflating the housing bubble. “Market observers, rating agencies and investors were unaware of the number of subprime and Alt-A mortgages infecting the financial system in late 2006 and early 2007,” he wrote.

Simply making the government support of Fannie and Freddie direct — an idea conference attendee Bill Gross of PIMCO proposed and Geithner implies support for — may produce slightly more honest accounting. But it would continue the distortion of government support for housing that is hurting both short-term growth, by channeling private funds to government-guaranteed housing instead of more innovative economic sectors, and long-term prosperity. The plan could add $1 trillion to U.S. national debt.

CEI has long advocated that the government both break up Fannie and Freddie and withdraw government support. More of the American public is coming to agree. A CNBC poll of its viewers today found that 68 percent believe GSEs are no longer necessary. While the poll is not scientific, it is significant, because CNBC’s viewers are not as conservative as those of Fox News or Fox Business.

Winding down Fannie and Freddie will not be easy, but it will not be the horrendous disaster many are painting. Interest rates would likely go up, but housing prices will almost certainly go down, meaning that housing would likely hit equilibrium for credit-worthy borrowers with modest incomes.

As CEI’s Smith has noted, there are “many American dreams,” and the claim of politicians of both parties that housing is intertwined with our economy is a circular argument. The intertwining is itself due to all of housing’s government backing.

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