Momentum Grows for Ending the Conservatorship of Fannie and Freddie

Author Bethany McLean used just the right phrasing to summarize core issues of concern in the conservatorship saga in a New York Times op-ed Monday previewing her upcoming book on the GSEs.

She noted then-Treasury Secretary Pauslon said the conservatorship was supposed to be temporary — a “time out.” She characterized the net effect of the Third Amendment Sweep as the creation of a “slush fund.” With regard to how to resolve the fates of Fannie and Freddie, she wrote, “The first step is to stop sending all their dividends to the Treasury. That would allow them to start rebuilding capital, eventually to a level substantially higher than what they were allowed to operate with before the crisis.”

McLean chronicled the Enron scandal in “The Smartest Guys in the Room.” Her forthcoming book on the GSEs, “Shaky Ground: The Strange Saga of the U.S. Mortgage Giants,” suggests an equal measure of skepticism about the players in the GSE transaction.

Investors Unite has no relationship with McLean and we are not promoting her book but her comments are worth flagging. She gives a good historical overview of what has been happening with the companies since the events of 2008, including this:

 “To make things worse, the government decided to ‘sweep’ almost all the duo’s profits into its own coffers, to be used as a slush fund for general government expenses. As Treasury Secretary Jacob J. Lew said in congressional testimony this spring, ‘As a practical matter it’s what has helped us reduce our overall deficit.’ If there is another downturn in the real estate market and Fannie and Freddie suffer losses on their some $5 trillion in outstanding securities, taxpayers will again have to foot the bill. Jim Parrott, a senior adviser with the National Economic Council in the Obama administration and now a fellow at the Urban Institute, wrote that the current system was ‘the worst of all worlds: It attracts too little private capital, provides too little mortgage credit, and still poses too much risk to the taxpayer.’”

Among the goals of the Housing and Economic Reform Act was the protection of taxpayers from another massive bailout should the GSEs wind up on “shaky ground” again. Of course, the government’s actions in the last few years have actually made the GSEs’ financial footing more precarious and deflated the cushion that would help protect the GSEs –  and thereby the taxpayers – against heavy losses during another economic storm.

 In her discussion of the past and future of Fannie Mae and Freddie Mac, McLean notes the GSEs made it possible for homeowners to access 30-year mortgages which have broad support. Accordingly, denying them the same levels of economic security the government insists on other financial institutions having and leaving them in limbo runs counter to the prevailing consensus.

We welcome another voice arguing that it is time to end the conservatorship and the Sweep and allow the GSEs to rebuild their capital buffers. In addition to McLean’s op-ed, CNBC’s Larry Kudlow argued in a segment over the weekend that shareholders should be compensated. This would return the rule of law and increase the confidence of investors. This, in turn, could lead them to increase the amount of private capital in the market.