Few people are happy with the limbo in which Fannie Mae and Freddie Mac currently dwell. The Treasury placed the two government-sponsored entities that buy and guarantee the bulk of all mortgages issued in the United States into a conservatorship in 2008 after the collapse of the housing market, which decimated the value of the loans they held and rendered the two insolvent.
The Treasury assumed ownership of just under 80 percent of the two and injected nearly $200 billion into them, for which Treasury assigned itself a dividend amounting to 10 percent of its investment.
Once the real estate market began to recover, Fannie and Freddie returned to solvency and began minting money. Recognizing an opportunity to claim an undeserved victory, the Obama administration amended the nature of the conservatorship and laid claim to the entire net wealth of the GSEs, to be swept into its coffers each quarter. Doing this allowed the administration to pretend it had both fixed a problem and made a step towards reducing our gargantuan federal deficits—the sweep put over $100b into Treasury coffers last year—but in reality it did neither. A Fannie and Freddie bereft of capital is the worst of both worlds, keeping the federal government on the implicit hook while doing relatively little to either reform their moribund operations or expand their portfolio in a sensible way.
The sweep displeased many in Congress, and it proved to be the cudgel needed to rouse the committees of jurisdiction into action. The Senate Banking Committee actually passed a bill with strong bipartisan support—Johnson-Crapo—that would replace the current GSE regime with something new while removing the implicit government guarantee on mortgage-backed securities, as well as force private lenders to absorb a portion of any future losses before the government backstop came into play.
In September the Congressional Budget Office released an official score of the bill, and found that if enacted it would reduce the deficit by $60 billion over the next decade—making it a rare tax-raiser in a world starved for such animals. The revenue gain gives it even more of a chance of becoming law, although still far from a sure thing.
The promised $60 billion is a bit illusory, however. The potential impact of enacting Johnson-Crapo on the federal budget—as well as on the mortgage market and the economy—depends on a number of assumptions, the most crucial of which is the counterfactual: that is, what would occur if the law were not enacted. CBO must assume that current law—that is, a world where the government indefinitely lays claim to all profits and the cumulative net wealth of the GSEs—reigns indefinitely. But that’s not a tenable status quo; absent the passage of legislation either Treasury or Congress would be forced to make some changes.
Simply reverting back to the terms originally set forth in the 2008 conservatorship, with the government owning 80 percent of a recapitalized Fannie and Freddie as well as receiving a 10 percent dividend, would give the federal government something worth more than a mere $60 billion, especially if it sold some of its stock, which would be worth much more than $60 billion.
Another issue with the estimate is that CBO—quite understandably—fails to take into account the small yet not-insignificant risk of another financial market implosion. While $60 billion is a reasonable expected value for the revenue generated from Johnson-Crapo, the reform effectively leaves the government on the hook should the current real estate and commodity markets prove to be a price bubble. While another loss of a couple hundred billion dollars from Fannie and Freddie may have a low probability of occurring, presumably the collective distaste for such an outcome and its attendant impacts would exceed the mere budgetary cost. And 2008 showed that we’re not very good at forecasting the probability of a “tail event” occurring.
The 2008 conservatorship represented the government making the best of a bad situation. Fannie Mae and Freddie Mac were the poster children for regulatory capture and for years pursued a reckless agenda that suited its executives and ostensible congressional overseers who benefited from its artificially-juiced profits. The conservatorship laid out a sensible reform plan from which the Treasury stood to gain—quite handsomely, in fact, should it have chosen to divest itself of some or all of the companies’ stock after the companies returned to solvency.
Instead, the government made another short-term decision when it issued the sweeps amendment, generating short-term gains used for baldly political purposes that left the GSEs worse off than before.
CBO’s report may seem to offer the government a modest gain to Treasury’s coffers while lessening its downside exposure, but this is deceiving. Johnson-Crapo does not absolve the government of its obligations in the event of another financial meltdown, and the $60 billion revenue gain is a pittance for what it gives up.
>Ike Brannon is a senior fellow at the George W. Bush Institute and president of Capital Policy Analytics, a consulting firm in Washington, D.C.
