How Do We Fix Fannie Mae and Freddie Mac?

The White House and Congress have proposed legislation to create a safer financial system in the wake of the recent crisis, but they have yet to deal with two of the biggest culprits: Fannie Mae and Freddie Mac (NYSE: FRE  ) . The two were guilty of doing exactly what Goldman Sachs (NYSE: GS  ) , JPMorgan (NYSE: JPM  ) , et al did: enabling a bubbly housing market.

The process of taking these agencies to account finally began Tuesday, when the House Financial Services Committee held a hearing on how to restructure the government-sponsored enterprises, as well as on the general future of our nation's housing-finance system.

Fannie Mae and Freddie Mac, which guarantee or own half of the nation's $11 trillion in mortgages, were taken over by the government in September 2008. Since then, the government has injected $127 billion into the duo and pledged unlimited aid to keep the housing market afloat.

To get a sense of how lawmakers are approaching the revitalization of America's housing-finance system, I spoke with Rep. Paul Kanjorski (D-Penn.), the chairman of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government-Sponsored Enterprises.

Here is an edited transcript of our conversation.

Jennifer Schonberger: You participated in a hearing Tuesday on how to restructure Fannie Mae and Freddie Mac, as well as the future of our nation's housing-finance system. Having discussed ideas in the hearing, what do you think is the best solution?

Rep. Paul Kanjorski: I think the first thing we should do is recognize that this is not going to be a problem that gets solved early or fast, or a solution that's going to come into use overnight. It's a work-out situation on the existing portfolio that Fannie and Freddie have -- and they're very sizable. Then, above and beyond that, it's the development of institutions that will further stimulate [commercial] real estate and residential housing in the U.S. and the determination of whether it's necessary to do that.

My judgment is, we do need something that will continue to stimulate housing and take the valleys and hills out of the problem ... Fannie and Freddie existed for a good number of years and were very successful in gaining a constant growth and prosperity in the residential real estate field. Now we've lost that ...

Can they survive now? They could probably be rehabilitated, but that would be expensive and take a long time. And on the other hand, we can't afford not having a support system for the residential real estate market in the U.S. So we're going to have to listen to all the suggestions, think the problem through, and then take steps -- but not giant steps -- and make sure that we do no harm to the field.

If you were to run in with a fast solution, you could cause depreciated assets to depreciate even more and cause even greater losses in the overall system ... Whatever that new system will be, it will have some of the same objectives as the old Fannie and Freddie, but with more safeguards in place so that you can't use it as an asset base for speculation.

Schonberger: Do we stick with a public/government-controlled system, or do we privatize it? And if we stick with a public system, should we put a hard cap on the number of loans that are doled out [or] homes that are subsidized?

Kanjorski: I think we have to recognize that we're in a dynamic, growing economy. So we cannot deal with hard caps, because if you put in a hard cap that would appear rational today, 10 years down the road it may become irrational, because of the growth of the population and the growth in the economy. So we have to be flexible and vigilant -- perhaps pay a little more attention to the needs of the economy and the society and be pliable enough to make those needs resolve. But don't let them run wild.

I haven't come to any conclusion. I know there's a segment of people who'd like to totally go to privatization. If we hadn't had a need for Fannie and Freddie, we wouldn't have had it. We had them because the private market didn't afford the opportunity to do what was necessary to create a secondary market for financing. That hasn't gone away. It's going to continue, it seems to me.

We could look at the need to have Fannies and Freddies, but not of the size that would put the system in jeopardy. We could create little Fannies and Freddies, and create them in such a way that if they got into financial difficulty, they could be allowed to collapse and it wouldn't be a big deal. What we had here is something that got so huge and so large that it would have created a whirlpool and brought down the entire system ... we had little choice. We shouldn't make those mistakes again in the future ...

Schonberger: When we look at fixing the system and what happened with Fannie and Freddie -- how they got caught up with the exuberance on Wall Street -- how much of it comes down to the government just enforcing prudence, ensuring that entities don't take on risk that is imprudent, as the government would do for any commercial bank like Citigroup (NYSE: C  ) or Wells Fargo (NYSE: WFC  ) ?

Kanjorski: Actually, this is a lot of our thinking now in how we're constructing regulatory reform. The Congress in ‘94 had authorized the Federal Reserve to establish conditions and circumstances for mortgaging. They did not do that. True, that was 16 years ago, but to a large extent you could trace some of those 16 years to deterioration in underwriting, and by virtue of that happening, a weakening of the system of Fannie and Freddie until it went critical ... We've got to try to make sure it doesn't happen again.

Schonberger: How long, in your estimation, before we revitalize the system?

Kanjorski: Certainly not months. I think we're talking about years -- probably two to five years to give an outside guesstimation before you can really come up with some workable solutions. If you try an area, you're going to make some mistakes, and on the other hand we can't allow this to happen indefinitely -- as it is now -- because we really don't have a functioning real estate market and are hurting a lot of people in the system.

Schonberger: Do you see yourself taking the lead on proposing any legislation around this?

Kanjorski: In our jurisdiction, we're certainly going to be working on it. I'm encouraging everybody who has ideas to synthesize them and send them to me and let's think about it. We have no preference. If we're going to make a hard decision, I'm going to encourage everyone on the committee who has ideas to throw them in the barrel. We'll try to pick something that we feel is the best solution.

How do you think we should fix the housing-finance system? Weigh in below!

More from Rep. Kanjorski:

Fool contributor Jennifer Schonberger does not own shares of any of the companies mentioned in this article. You can follow her on Twitter. The Motley Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 26, 2010, at 9:12 AM, taintedfud wrote:

    i would like to have ms Schonberger expand on what i consider her extremely incorrect statement. "...ensuring that entities don't take on risk that is imprudent, as the government would do for any commercial bank like Citigroup (NYSE: C) or Wells Fargo (NYSE: WFC)?" or bac,MS, GS, wamu, indymac,countrywide, wb, ml,leh,bs.aig. also rbs, ing, aeg, and most of the rest of the too big to fail banks.

    only fnm/fre were at fault? only fnm/fre were too big to fail? if that be the case, why tarp, why what some think to be 2 trillion dollars out there to save the world?

  • Report this Comment On September 20, 2010, at 11:15 PM, chrisanja wrote:

    There may be no perfect solution. Certainly, Americans have relied on the government's support of housing, through tax incentives and mortgage market supports for decades.

    As John Taylor (NCRC) has stated, "Don't throw the baby out with the bath-water". Everyone was blindsided by the run-away excesses of the bubble, and Fannie and Freddie's support over the last year has provided < 5% interest rates during a time when the 'private sector' would be charging 8% or more. We did not, and do not, need housing to 'adjust' another 10-30%, either. Both of these would have happened according to Wharton's Susan Wachter and PIMCO's Bill Gross.

    Many uninitiated parties seem to think that Fannie and Freddie can just be shut down and then we can move on - this is absolutely not true. Edward DeMarco (FHFA) and former Treasury Secretary Henry Paulson know that the mortgage industry and probably America would be in a deep Depression had Fannie and Freddie gone into receivership. And, this is still the case.

    The main point is that the US govt. has unjustly charged these two companies 10% interest for their assistance during this crisis. Of the $150B that has been infused and invested, $16B is from interest alone. Furthermore, large banks are not accepting the shoddy loans back.

    The answer: Do not treat Fannie and Freddie so unfairly. Citibank and AIG shareholders have seen marked improvement since the government decided to use (or will use) "common equity" in the place of a large debt burden.

    If the US govt. would merely convert their senior preferred position to common stock and share the $8.6B perpetuity that Fannie Mae is being charged, these benefits would come about:

    1) The US taxpayer would not have a cost, but an investment. That investment would be worth over $20B more than what they paid, for Fannie alone

    2) The junior preferred holders, many of which are community banks, would be able to lend on the restored value of their holdings, thereby increasing the capital by $150-200B.

    3) Many US citizens, holding Fannie common and preferred stock would have their company and trust in govt. restored. The 'cost' of paying these dividends to Main Street investors has been severe.

    As Donald Manzullo (R-IL) pointed out, banks do not need exotic lending programs, they just need the govt. to make good on the investment in Fannie that was made over two years ago - in some cases, under the guidance of their regulators who assured them that investing in Fannie and Freddie was safe!

    I've put together a few point which outline the 'plan' and reasons for why now is the time to revitalize Fannie and Freddie with a simple restructuring that is similar to Citi and AIG

    http://www.cubris.com/fanniemae_recapitalization_plan.htm

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