By Ronald A. Cass – 07/10/14 01:35 PM EDT
Like Charlie Brown — ever hopeful of kicking the football — players in the U.S. housing market have been hoping for congressional proposals for home finance reform that were not mere enticements to foolish investment or greater taxpayer burden.
Each crisis in the market has underscored problems with congressional reform proposals and has invited new efforts to make things right. But in every case, short-term interests or misunderstandings of what needs to be fixed have, like Lucy, pulled the ball away.
Since the 1930s, government-sponsored enterprises (GSEs) Fannie Mae, and later Freddie Mac, were supposed to assure liquidity in the housing market, with a sometimes implicit (sometimes explicit) government guarantee that would lower borrowing costs, protect investors and help promote homeownership.
Increased homeownership and a vibrant housing market seemed to signal their success. But in the aftermath of the financial crisis and changes in the incentives offered to mortgage issuers, the GSEs were left on the hook for much of the cost, and it was obvious that something needed fixing.
The 2008 Housing and Economic Recovery Act (HERA) placed the GSEs in conservatorship under the Federal Housing Finance Agency (FHFA) and provided substantial cash infusions in exchange for an annual 10 percent dividend on investment (i.e., on the government’s “senior preferred stock”) and rights to almost 80 percent of the GSEs’ common stock.
As the market improved, Fannie and Freddie’s finances improved, too. They now have paid “dividends” to the U.S. Treasury above the $188 billion received as bailouts. The GSEs seemed poised to return to profitability and a more stable operation. Then the U.S. government picked up and moved the ball again.
The FHFA unilaterally amended the HERA-based agreement, eliminating the rights of nongovernment shareholders and sweeping up 100 percent of the profits generated by the GSEs in perpetuity. This “third amendment” to the agreement also reduces capital holdings for the GSEs, making their operations more secure and decreasing need for taxpayer support.
These changes are being challenged in a lawsuit, Perry Capital v. Lew, but it should not take court action to see that there is a problem with the third amendment.
From a policy standpoint, this mini-nationalization seems totally backward. Aside from questions of its legality, the amendment diminishes incentives for private investment needed to boost liquidity for the housing market. It downgrades the security of Fannie and Freddie at a time when the still-undercapitalized GSEs could afford to increase capital assets simply by deferring new dividend payments.
While the FHFA policy provides more money now for the Treasury (which the government can spend on other priorities), the policy contradicts basic common sense. It’s as if, after a young adult moves back home, his parents seeing him saving very little and making potentially risky investments, direct him to save less and give them his paychecks—for them to spend!
A more sensible alternative is for the FHFA to reverse the third amendment, begin rebuilding GSEs’ capital, and put the enterprises on a sound footing to exit conservatorship, as AIG, GM, and other recipients of federal stopgap funding during the economic crisis already have.
A recent report from the Height Analytics group of financial analysts explains that this could make GSEs financially sound in 5–10 years, depending on how high the FHFA sets capital asset requirements. Moreover, this would give Congress better options regarding long-term GSE reform and less time pressure for acting.
With the $10 trillion to $20 trillion U.S. housing market representing much of the wealth of 70 million American homeowners, it is time for government officials to put the largest sources of mortgage-finance backing on sound footing. Financially secure GSEs are good for the housing sector and for home investment. Making a sensible move in this arena would bring a smile to Charlie Brown fans who’ve waited too long to see him kick the ball.
Cass is dean emeritus of Boston University School of Law, a U.S. representative on the panel of mediators for the World Bank’s International Centre for Settlement of Investment Disputes, and author of The Rule of Law in America.