More Circular Reasoning on GSE Recapitalization and Reform

If only we could adopt the solutions staring us right in the face, then maybe we could meet our objectives for a better housing finance system. That seems to be Mortgage Bankers Association President Dave Stevens’ lament in a blog posted last Thursday commenting on the latest earnings from Fannie Mae and Freddie Mac.

Last week, Freddie Mac announced a quarterly loss of $475 million and Fannie Mae reported a profit of $2 billion. Yes, the numbers are down in comparison to the same period last year, but this was mostly due to accounting adjustments and not market performance.

Strangely, Stevens argues that the earnings statements are reminders of the risk of a conservatorship that deprives Fannie and Freddie of capital while simultaneously arguing that recapitalization and release is neither “politically feasible nor financially wise” – apparently, in part, because of their lack of capital.

Why would recapitalizing Fannie and Freddie be financially unwise? With Fannie Mae’s latest $2.2 billion payment to the Treasury, the GSEs will have paid back nearly $55 billion more than they were loaned in the housing crisis in 2008. Over the past year, Freddie Mac has earned $4.5 billion, which calculates to average quarterly net income of around $1.1 billion. Fannie Mae, meanwhile, earned $9.8 billion over the last year, an average of $2.45 billion per quarter. The fact is that Fannie and Freddie remain enormously profitable businesses which are intrinsic to American homeownership, so it does not seem like such a gamble to improve their financial footing while they continue to undertake reforms. In fact, explicitly eroding their capital base to zero, as the Sweep will do by 2018, leaves taxpayers directly exposed to even the slightest losses in a down quarter. 

And why is it not feasible politically? Stevens’ explanation rests on a circular argument, a self-fulfilling prophecy: The Administration opposes recapitalization so why bother talking about it?

“Clearly, the status quo is unsustainable. And MBA will continue to work with the Administration and Congress to find ways to improve the secondary mortgage market, including the future of the GSEs,” he wrote. “But let’s be clear. Recapitalizing and releasing the GSEs without fundamental reform is, to put it simply, unrealistic.”

Stevens asserts that he and the MBA are for reforming the GSEs, not replacing them. He speaks about their critical role in the housing finance system and reiterates his elements of “true reform” that include reducing the risk to the taxpayer by having the explicit guarantee back only the mortgage securities and not corporate entities, risk sharing to leverage private capital, and preserving the GSEs’ missions to access to affordable home purchases and rental housing are maintained. 

The critical question he poses is “how do we avoid an overreaction to these earning scares?”

The answer is in not overreacting and instead keeping the focus on workable solutions.  There can be a robust debate on the ideas Stevens and others propose, but the place to start that debate is by following the Housing and Economic Recovery Act and making the companies sound and solvent instead of starved for capital.

On the same tautological limb, The Wall Street Journal’s John Carney pounced on the earnings statements, asserting the data proves they simply don’t have the consistent earnings power needed to recapitalize themselves. And one of the reasons he cites? The Sweep.

Basically, the government is holding two profitable companies captive and deliberately undermining those companies’ financial position. It would not be an overreaction to stop that policy. In addition, the warrants that Treasury holds could easily become part of recapitalization and reform proposal. Instead of fretting about the political and financial complexity of reinventing the wheel, why not start by putting the wheels back on the car? 

Stevens might be right that there is not the political will to act. This is a surprise given the solid support among the Obama Administration’s political base for reforms to improve lagging access to affordable housing. But neither Treasury nor any private sector stakeholder can use the financial state of Fannie and Freddie to say recapitalization is not feasible. It will remain unfeasible only as long as foes of the GSEs’ refuse to honestly consider the policy options before them.