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The Wall Street Journal Takes Aim at Risk Sharing and Ignores the Law

The Wall Street Journal’s lead editorial on New Year’s Eve was laden with such contempt for Fannie and Freddie that it ignored facts central to shutting them down for good, as the Journal professes to want.

For some reason the Journal put the word “conservatorship” in quotes and sneered at the Federal Housing Finance Agency because it “seems to view itself as the official preserver of Fan and Fred’s market share.” 

It is not exactly clear why quotation marks were needed since, in fact, the Housing and Economic Recovery Act did place the GSEs into this arrangement with FHFA as conservator. FHFA has not dreamed up a mission for itself, as the Journal suggested. HERA required FHFA to return the GSEs to a “sound and solvent condition” and preserve the GSEs assets in anticipation of an eventual reform plan. As we know, a reform plan has not emerged during the last seven years. Whatever power the law provides, the Obama Administration has chosen not to use it and instead hunkered down in its position to wind down the companies by attrition. With its hands tied, FHFA has simply been doing what it can to make internal reforms needed to create a bigger role for private capital.

The Journal objects to how this is being done, castigating Fannie and Freddie for using collateralized debt obligations to offload some of the mortgage risk they are holding, namely Connecticut Avenue Securities, asserting, “these new instruments are essentially a way for the mortgage giants to buy insurance against the possibility that lots of mortgage borrowers don’t repay the money they owe.”  The newspaper continues:  “But how about simply not holding these risks in the first place? Then taxpayers would have no need for insurance.”

Whatever the merits of such an idea, FHFA cannot simply direct Fannie and Freddie to abdicate their mission and arbitrarily dissemble. That would be in opposition to HERA. Besides, what would take the GSEs’ place? The Administration has offered no plan, and Congress thus far has not succeeded in formulating a way out of the conservatorship and creating a better mortgage finance system.

The Journal takes issue with FHFA’s risk-sharing innovations, saying, “You won’t be surprised to learn that investors have been more eager to take on mortgage risks via these new Fannie and Freddie securities than via private mortgage-backed bonds, a market that has hardly revived since the financial crisis. Why would investors rather deal with Fan and Fred than with a private seller of mortgage risk? Well, it could be because the Beltway geniuses who brought us the housing crisis are so much better at selecting quality mortgages and managing credit risks than private firms. Or could it possibly be that investors prefer having Uncle Sam standing behind the deal?”

What the Journal’s commentary ignored is that in the absence of a comprehensive strategy for recapitalizing Fannie and Freddie and moving on from their conservatorship, risk sharing will continue to be an untested and piecemeal approach from bringing in more capital to the mortgage finance system, made only more glaringly insufficient by the companies’ inability to maintain a buffer against losses of their own.

Regardless of one’s position about what, if any, role GSEs should play in the modern housing finance system, it is important to know where the capital will come from to make the purchase of homes feasible for average Americans.  Former Federal Deposit Insurance Corporation Chairman William Isaac pointed this out several months ago and the question remains unanswered. The Journal might not like the risk sharing innovations of Fannie and Freddie but, so far, investors have hardly jumped at them in numbers to supplant Fannie and Freddie.  As the Journal itself reported just a few days before its final editorial of the year, the GSE’s have sold only about $25 billon of the new securities during the last two years – which is just a drop in the $5 trillion mortgage ocean. Whether one loves or hates Fannie and Freddie, we’re a long way from being able to replace the amount of capital and market liquidity they have provided.

The Journal should be calling on Congress to use 2016 to probe the anatomy of the conservatorship and to hold hearings on how to bring it to an end.  The alternative is to continue to grumble about a situation everyone knows is not working for homeowners, shareholder, taxpayers or capital markets.