Where GSE reform went wrong

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It was an early Sunday morning on September 7th, 2008. I had just received a call at home from the public relations office of the U.S. Treasury Department that Secretary Hank Paulson and James Lockhart, director of the Federal Housing Finance Agency, wanted to talk with the heads of the major financial trade groups at 2pm that afternoon.

When the time came, Secretary Paulson joined the conference call line and informed us that Fannie Mae and Freddie Mac had been placed in conservatorship the previous evening.

Stunned silence followed — a silence so deep that it was deafening.

Conservatorship of the housing giants was supposed to last just a couple of years, but it’s now stretched on nearly a decade. Bloomberg News

As if sensing the shock of the participants, Paulson hastened to say that this move was necessary, but that it was only a “time out” and he expected the conservatorships to last only a couple of years at most. Thus started a now nearly 10-year saga of miscalculations, mistakes and a lack of political will by six Congresses and three administrations.

Placing the two largest government-sponsored enterprises into conservatorship was the first and perhaps most egregious mistake. It marked the triumph of FM Watch — the coalition of Wall Street megabanks that had been working to bring down Fannie and Freddie for more than a decade. Ironically, the realization of that goal was accomplished at the same time that most of those megabank coalition members were crashing and burning themselves.

September 2008 was a chaotic month in American financial history. A kind of hysteria gripped the financial world and much of the general public as well. Our largest financial institutions and our government flailed about desperately trying to staunch the financial bleeding and chaos, and those with very large axes to grind saw their chance to end the two enormous housing GSEs. Would the GSEs have failed outright had Paulson and Lockhart not stepped in on that September weekend? That question is open to considerable debate. Many highly respected financial thought leaders do not believe so. And those on each side of the argument have their facts and figures.

But there is no argument that the GSEs recovered their financial health much more rapidly than anyone dreamed they could. And as they were recovering, the new Obama administration, under Treasury Secretary Timothy Geithner, saw an opportunity to “cut a fat hog” as we used to say in rural Missouri. And cut they did. They seized 100% of the income produced by the GSEs, wiping out private equity holders in the process. In effect, they seized private property for government benefit (and severely crippled hundreds of community banks in the process). By seizing all the profits of the two GSEs, they assured that the government coffers would be handsomely fed and that the GSEs would never emerge from conservatorship unless the Congress dealt with the problem, which it has been loath to do.

In my view, statutes have been ignored or outright violated. Is the duty and obligation of the conservator, the FHFA, to keep those entities under conservatorship in perpetuity? Or is the conservator’s responsibility, nay, its duty, to rehabilitate the entities in conservatorship so they may stand on their own again and function as before? If the answer is the former, then the government has been disingenuous and should have forced the GSEs into bankruptcy in the first place.

What about Congress? Well, over the past decade Congress has either come up with plans that I would refer to as the “Wells Fargo Full Employment Act,” or it has created proposals so convoluted and complex as to collapse under their own weight when exposed to critical review.

It has been my experience that the harder the issue with which Congress must deal, the further the can gets kicked down the road. There’s extremely high risk in creating a new, untried multi-trillion dollar mortgage market — what if it doesn’t work? It will take a great deal of political will for such a change to occur. And in the political environment of today, where will that kind of political will and risk-taking come from?

The value of mortgage debt on family residences in the U.S. tops $10 trillion, over half the U.S. GDP. Where does the money come from to replicate the existing GSEs with a new scheme? Private investors are not going to take long-term risk without enormous guarantees and pledges, which will drive the cost of mortgages through the roof for the average homebuyer. And what happens when another 2008 financial crisis comes and our multi trillion-dollar mortgage system is only backed by private capital, which in a 2008-like crisis will melt faster than a snowball on a south Florida beach in July?

We all know who will be forced to step in — taxpayers.

These issues are very complex and very difficult. At this point there are no easy or clean solutions. And neither Congress nor the White House wants to be without a chair when the music stops.

Camden R. Fine

Camden R. Fine

Camden R. Fine is president and CEO of Calvert Advisors, LLC. He was previously president and CEO of the Independent Community Bankers of America.

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