Just before Thanksgiving, Senator Bob Corker (R-TN), proposed an amendment that would essentially prohibit Fannie Mae and Freddie Mac, the government-sponsored enterprises that purchase, repackage and resell home mortgages, from taking any steps to rebuild capital or to sell any of the government’s preferred stock in either company. The amendment may have failed but it is far from dead, and is likely to be resurrected in the future.
That the provision won’t stay dead is a shame, because it is bad policy for numerous reasons. For starters, it directly interferes with the ability of the conservator (the Federal Housing Finance Agency, or FHFA) to fulfill its statutory function of restoring the companies to fiscal soundness. What’s more, it would interfere with ongoing litigation by preventing the government’s ability to settle with investors who have sued over the Third Amendment Sweep. Finally, it circumvents “normal order” of the Senate by doing all of this without so much as a hearing or debate.
The status quo for Fannie Mae and Freddie Mac is plainly unsustainable, but Senator Corker’s provision wouldn’t be an improvement over the current morass.
First, some background: Fannie Mae and Freddie Mac have been in a conservatorship administered by FHFA since 2008, when the U.S. Treasury provided $187.5 billion of capital to shore up their balance sheets at the beginning of the financial crisis. The government created the conservatorship shortly after the passage of the Housing Economic Recovery Act (HERA), which created FHFA and gave Congress the authorization to create the conservatorships and appoint FHFA as conservator. HERA clearly specifies that the FHFA’s mission is to conserve the assets of the GSEs and restore the companies to solvency for the shareholders.
However, Corker’s proposal interferes with the conservator’s statutory duty and perpetuates the current risk to taxpayers by depriving Fannie and Freddie of capital by codifying the Third Amendment Sweep. Another problem with Corker’s amendment is that it interferes with ongoing litigation that potentially provides a more expeditious solution to the current GSE crisis. The lawsuit stems from the post-HERA actions of the U.S. Treasury. When the Treasury assumed conservatorship of Fannie Mae and Freddie Mac in 2008 it assumed just less than 80 percent of the company’s stock in exchange for its investment. The shareholders essentially lost 80 percent of their stock, and many of them decided to unload their remaining shares then for a pittance.
Those who held onto their stock were betting that the housing market would turn around quickly and that this would return the agencies to solvency. That turned out to be a good bet; by the end of 2011 the two began generating profits again.
However, that development didn’t end up benefiting the remaining shareholders after all: In 2012 the Treasury effectively scuttled the conservatorship with its third amendment, which effectively resulted in Treasury “sweeping” the entire net profits of Fannie and Freddie into the Treasury’s coffers each quarter. The sweep obviated the claims of the remaining shareholders on a portion of the company’s profits.
A group of these shareholders sued to force the Treasury to re-implement the terms of the original conservatorship, and the lawsuit is currently in front of a federal appeals court, so Corker’s amendment interferes with ongoing litigation. If the lawsuit were to succeed the federal government would no longer be able to claim the entire net wealth of the GSEs, but it would still receive a 10% dividend on the GSEs’ profits and could also sell its share of the company, which could exceed $100 billion by some estimates. Given that the money that has been “swept” into Treasury from Fannie and Freddie thus far already exceeds the government’s injection into the GSEs it would be hard for taxpayers to get too upset at such an outcome, especially if it helps get Treasury off the hook for future losses.
Fannie Mae and Freddie Mac play an important role in the housing market, but their collective missteps contributed to the housing bubble and subsequent financial crisis in 2008-2009. What these look like in the future is an incredibly important issue worthy of debate: the political pressure already being applied on the two to be more liberal in the quality of mortgages it buys and to lower down payment requirements suggests that if we simply allow the status quo to exist it’s conceivable we might end up with a similar mess down the road.
Congress should be holding regular hearings to debate the status of Fannie Mae and Freddie Mac, how we might structure the housing market going forward, and what might be some possible alternatives to HERA–which might include privatizing the GSEs or doing away with them altogether.
Trying to resolve this issue in via a last-minute amendment is a lamentable short-circuit of the political process that doesn’t do this issue justice. It is complicated, messy and controversial to be sure. All the more reason for Congress to proceed slowly and carefully but deliberately in fixing the current untenable situation.
Ike Brannon is president of Capital Policy Analytics, a consulting firm in Washington, D.C.
