Now Everybody Is Talking About Ending the Conservatorship

As 2017 opens, could ending the conservatorship of Fannie Mae and Freddie Mac be fairly easy after all? Now in its ninth year, the complexity and size of the undertaking – not to mention the politics involved – has proven to be too much for Washington but the incoming Trump Administration might be ready to tackle the issue with a little common sense and decisiveness.

Just after his selection was announced in November, Treasury Secretary-designate Steve Mnuchin told Fox Business News that getting Fannie and Freddie “out of government control” would be a “top ten” priority for the Trump Administration and expressed confidence that the process could be completed quickly and with relative ease.

Echoing this optimism in the Wall Street Journal a few weeks later, former Federal Deposit Insurance Corporation Chairman William Isaac and Richard Kovacevich, retired chairman and CEO of Wells Fargo & Co., agreed that moving to a privatized secondary mortgage finance system would be “easier than it seems.”

While it is clear that the release of Fannie and Freddie from government conservatorship would be a welcome development for shareholders and taxpayers, and that reforms are needed in housing finance policy, this must be accomplished in a way that honors obligations to all stakeholders.

“The U.S. needs a new mortgage system that preserves the value that currently exists with Fannie and Freddie, never places taxpayers at risk again, promotes homeownership at affordable levels, and transitions to a new private model without disrupting the housing industry,” wrote Isaac and Kovacevich on December 15, adding. “Congress will also need to resolve the issues with shareholders of Fannie and Freddie resulting from the Obama administration’s unilaterally changing the terms of conservatorship in 2012 by seizing their capital and future profits.”

While their acknowledgement of the legitimate claims of shareholders was appreciated, it would be reassuring to see some details on how it will be possible to wind down Fannie and Freddie and replace them with a privatized system while still preserving shareholder rights.  If the solution is replacing Fannie and Freddie, as Isaac and Kovacevich seem to favor, there seems little reason to trust that the government will get it right.  Its misapplication of the Housing and Economic Recovery Act and the Net Worth Sweep, not to mention the jaw-dropping extent to which the government has tried to conceal its deliberations in ongoing litigation, make up one of the most disturbing sagas of governmental obliviousness to the rule of law in decades. Unbinding Fannie and Freddie from the financial straightjacket the government has imposed would involve a lot of complex policy questions. The Wall Street Journal has acknowledged this in its reporting.

Mnuchin specified that the companies would have to be “restructured” so they are “absolutely safe.” This could mean a simple recapitalization or it could mean some broader reworking of the companies and their roles.  While FHFA as conservator has the authority to begin recapitalization now, a broader re-working would require legislation by Congress.  For starters, Treasury Secretary Mnuchin should encourage FHFA Director Mel Watt to rebuild the GSEs’ capital base.  This is a crucial for protecting taxpayers, as the companies still face the threat of a draw as long as the net worth sweep continues to strip them of their profits. 

If Fannie and Freddie were to be wholly replaced by a private system, as Isaac and Kovacevich envision, then where would the capital come from needed to replicate Fannie and Freddie’s role in backing some $5 trillion on mortgages?  Interestingly, Isaac has wisely raised this important question in the past and concluded that any combination of banks, mortgage insurers and other investors do not have such vast amounts of capital waiting to be deployed.

It is worth noting that Isaac and Kovacevich acknowledged the companies have also repaid taxpayers more than $240 billion against their $187 billion bailout from 2008. That was capital that should have been used to restore the solvency of Fannie and Freddie as HERA required.

Mnuchin’s words signal a long overdue acknowledgement that a workable way out of the conservatorship is an urgent matter and a fresh perspective might be useful. At the same time, any plan for reform, recapitalization, and release must respect the rights of shareholders and be in the best interests of American taxpayers, homebuyers and capital markets.