Conservative Angst & Letting the GSEs “Sink or Swim”

September 4, 2014

As if violating the rule of law wasn’t enough of a reason to end the U.S. Treasury Department’s conservatorship of Fannie Mae and Freddie Mac, we would like to offer up another almost-equally compelling reason: If the mortgage giants are going to be successful in shoring up the nation’s housing market, they must be free of political forces that could influence how they are run.

To wit, the Washington Times and the Washington Examiner this week published two very interesting pieces that helped us along this path – a column in the Washington Times from James K. Glassman and an article from Washington Examiner reporter Joseph Lawler. Glassman, a former Undersecretary of State for Public Diplomacy and Public Affairs, argues that it’s time for Fannie and Freddie to “sink or swim” on their own merits. While the idea of government management is usually laughable, the mortgage giants have become “spruced up, profitable and well-managed” and are on track to earn a combined $20 billion in profits this year – more than General Electric, Glassman notes. He has a great take on why the illegal conservatorship is actually costing the government more money than it’s taking in through the Third Amendment Sweep:

[T]he irony is that this perpetual conservatorship may be costing the Treasury money at the precise time that the federal deficit has been running at near-record levels.

Here’s why: Right now, Fannie Mae and Freddie Mac are highly profitable and, in the open market, would be worth hundreds of billions of dollars. Although many in Treasury considered the common stock of the mortgage funders worthless in the depths of the crisis, the government’s stake now represents the largest commitment fee in financial history.

What can the government do with this ownership stake? Convert it to cash. Private investors want to restructure Fannie and Freddie, and have already plowed huge sums into the firms. If restructured, Fannie and Freddie could be relisted on the New York Stock Exchange, and Treasury’s shares sold over time to public investors. The government would get out of a business it shouldn’t be in. The current ward-of-the-state condition is unsustainable.

If Fannie and Freddie earn a combined $20 billion annually (a conservative estimate), then, at a modest price-to-earning ratio of 13 (compared with an average of 15 for the three largest U.S. banks), the market capitalization of the two would be $260 billion, and the 80 percent stake owned by the government would be worth $208 billion. Add that to the $218 billion Fannie and Freddie have already paid the Treasury, and the total take is $426 billion — for a profit of 128 percent.

The Washington Examiner article, from Lawler headlined “Conservative Analysts Warn of Growing Fannie & Freddie.” The article is based on the recent FHFA announcement that it is looking to set new affordable goals but that action is according to Lawler, “the latest in what right-of-center analysts see as in a series of decisions meant to increase the businesses’ market impact, rather than eliminate it.” From the article:

The Federal Housing Finance Agency is proposing to increase the number of home loans for people in low-income areas and for people in multifamily housing such as condos and townhouses. The goals, which the agency is required by law to set, are for the years 2015-2017.

Coupled with a decision by new FHFA Director Mel Watt earlier in the year to cancel an increase in the fee it charges for government insurance on mortgages — a move that will ease credit terms — Friday’s announcement concerns [Andy] Winkler [a researcher at the American Action Forum].

“The overall tone shift from shrinking the government-sponsored enterprises to maintaining broad access has conservatives worried,” Winkler said.

Look, no one wants a repeat of the 2008 financial crisis, the roots of which have been very well explored. Fannie Mae and Freddie Mac needed help at that time; their shaky standing in the housing market threatened its overall viability. So the government stepped in to shore them up with a taxpayer bailout – a bailout, that many including Mr. Glassman, note has been repaid and then some.

Conservative angst aside about what the Administration is doing, the elephant in the room when anyone discusses reforming Fannie and Freddie or housing market policy is that the federal government continues to ignore shareholder rights, which go hand-in-hand with the American dream of home ownership. We do think that FHFA Director Mel Watt should pursue efforts to secure affordable housing, but we believe that the clearest pathway to reaching this goal is by allowing Fannie and Freddie to re-capitalize, giving them proper regulations and restoring them to the marketplace. The failure to end the Conservatorship the jeopardizes the GSE’s mission of providing affordable housing for all Americans and specifically those Director Watt is trying to reach with his proposal.