For decades, the mortgage giants Fannie Mae and Freddie Mac were the fat and happy foundation of the U.S. housing market. By buying and packaging home loans into bonds and absorbing much of their risk, they made it easier for homebuyers to get mortgages, and to get them on easier terms than are available in most countries. Created by the government and then spun off as shareholder-owned corporations, Fannie and Freddie churned out steady profits, as investors treated their debt as virtually risk-free. It was the best of both worlds — until the housing market melted down in 2008. The government’s bailout of Fannie and Freddie cost $187.5 billion. Fannie and Freddie have more recently become hugely profitable, and the housing market is more dependent on them than ever. But their days as wards of the state may be coming to an end.

The Situation

In December, a bipartisan effort to overhaul Fannie and Freddie began to move forward. Senators Bob Corker, a Tennessee Republican, and Senator Mark Warner, a Democrat from Virginia, are working on a plan that would preserve Fannie and Freddie but make it easier for investors or other companies to create competitors. Their proposal would give mortgage bonds issued under the new system an explicit government guarantee, and create a new government fund to protect taxpayers in case a private mortgage-financing company fails. While reform plans have inched along, Fannie and Freddie have been pouring money into the U.S. Treasury, which has received more than $275 billion in dividends from them since 2008. Those payments prompted lawsuits by a number of investors who challenged a change in the terms of the bailout that reserved all profits for the government. In February 2017, an appeals court mostly upheld a lower-court judge’s 2014 decision to dismiss one of the shareholders’ cases against the government.  Investors appealed that decision to the Supreme Court, which hasn’t yet decided whether or not it will accept the case. 

The Background

Congress created the Federal National Mortgage Association in 1938 as a government agency with a mission of reviving the mortgage market after its collapse in the Great Depression. Traditionally, banks that made mortgages held on to them. By buying mortgages from lenders, Fannie Mae, as it became known, freed up money that the banks could use to make more loans. After World War II, that process helped fuel a housing boom and made 30-year fixed-rate mortgages the American norm — in most other countries mortgages have shorter terms or adjustable rates. In 1968, Congress converted Fannie into a for-profit, shareholder-owned company, in part to ease a debt burden fueled by spending on the Vietnam War. Freddie Mac, the Federal Home Loan Mortgage Corporation, was created as a federally-chartered corporation in 1970 to give Fannie Mae some competition. It was turned into a publicly traded company in 1989. The companies helped the market for mortgage-backed securities grow by guaranteeing the payments of bonds it sold — bonds that many investors treated as nearly as safe as those of the U.S. Treasury, because of what was seen as an implicit government guarantee. That meant the companies could borrow more cheaply than other lenders. Some conservative economists say their collapse was caused by Congressional requirements to back lending in poor areas. But most studies have pointed to their small capital reserves and decision to expand their investments in loans packaged by Wall Street during the housing boom, including subprime bonds. Fannie and Freddie now stand behind about half of new U.S. mortgages, compared with about a third in 2005.

The Argument

Since 2008, most of the plans put forward in Congress involved shrinking the amount of mortgage-credit risk backstopped by the government and winding down Fannie and Freddie, including an initial package from Corker and Warner.  But that prompted opposition from affordable housing groups and small lenders, and Warner said the new proposal reflected the realities of coming up with an approach “that protects the taxpayer, preserves the 30-year fixed mortgage, and includes robust access and affordability provisions.” But a plan that involves a substantial government guarantee might not win over conservatives. A less ideological issue is whether to compensate shareholders who were wiped out when the government seized the companies in 2008. Investors in the companies include several prominent hedge funds.

 

First published Aug.

To contact the writer of this QuickTake: Joe Light in Washington at [email protected]

To contact the editor responsible for this QuickTake: John O’Neil at [email protected]

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