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Taxpayers are NOT Capital – Taxpayers are PROTECTED BY Capital

Happy 5th Birthday Dodd-Frank! To celebrate, Congress is serving up an extra big slice of scrutiny.

The U.S. Senate Banking Committee held a hearing Tuesday on non-bank Systemically Important Financial Institutions (SIFIs) while the Federal Reserve is coming out with new capital rules for banks. But two of the largest financial institutions in the country, Fannie Mae and Freddie Mac, are barely part of the discussion because Dodd-Frank omitted them. Indeed, amid lawmakers’ criticism of Dodd-Frank’s overreach and ham-handedness, it is ironic that the law apparently did not end “too big to fail” and will apparently not prevent future bailouts, as supporters hoped.

On top of that, the flawed and illegal interpretation of the Housing and Economic Reform Act, the legislation aimed at making sure the GSEs would be able to provide capital and liquidity in the housing finance market, all but guarantees that Fannie and Freddie will need more support from taxpayers. As we have warned for months, it is reckless to leave these huge enterprises with no capital. Lawmakers concerned about the logic of capital requirements for large banks should be at least as concerned about the vulnerability of the GSEs.

A story in the Washington Times on July 21 noted that former FDIC Chairman William Isaac warned in an opinion in the Wall Street Journal back in March that the GSEs would likely need to be bailed out by taxpayers again since the Treasury continues sweep their capital in the general fund.   

With all the outrage about Dodd-Frank from both sides of aisle, the public should be asking Members of Congress why Congress and the Administration think it is acceptable to let the flawed conservatorship continue without end. Do Washington policymakers assume taxpayers will simply provide whatever capital is needed during the next economic downturn? Once the tab for the Third Amendment Sweep needs to be paid, will taxpayers be expected to protect policymakers from their mistakes?

Here is the answer: Taxpayers are NOT capital. Taxpayers are protected by capital.

To be sure, Tuesday’s Senate Banking Committee hearing was the not first opportunity for Congress to consider the illogic of letting Fannie and Freddie remain in this dangerously undercapitalized state. In May 2015, U.S. House Financial Service Committee Chairman Jeb Hensarling opened a hearing on the Financial Stability Oversight Council by pointing out the hypocrisy of the federal government handing out “too big to fail” designations on imposing capital standards on non-bank institutions such as insurance companies.

“In contrast, there were Fannie Mae and Freddie Mac, which lay at the epicenter of the financial crisis. They were highly-leveraged before the crisis and remain highly-leveraged today.” Hensarling added. “They are not only a source of systemic risk—they are its very embodiment.”

Given the Treasury’s continued draining of Fannie and Freddie, the casual observer would be excused for believing there are no capital requirements for the enterprises. But given the massive role the GSEs play in the housing sector, it is especially important that they build and maintain higher capital reserves. Indeed, such larger reserves would be the first line of defense for taxpayers who will be on the hook should either company need another bailout.

The sooner the “Sweep” ends and the GSEs start building their capital reserves so they are sound and solvent as the law requires, the sooner capital will protect taxpayers and the less likely taxpayers will have to provide capital.