This post was written for The Ground Floor by John McIlwain, senior resident fellow of Housing at the Urban Land Institute.
Yesterday, Sunday, September 07, 2008, an Administration philosophically committed to the "free market" nationalized the U.S. housing finance system. Yes, "all" that was done was to put Fannie Mae and Freddie Mac into "conservatorship" -- whatever that means -- and under the direction of the new Federal Housing Finance Agency (which is much like the old OFHEO on steroids).
But with Fannie and Freddie buying up between 70 percent and 80 percent of all the mortgages being made in the U.S. these days, the federal government now controls the U.S. housing finance market directly.
We're not in Kansas anymore, Dorothy. In fact, we are not anywhere we have ever been before, and are plowing new, uncharted waters. Seventy years ago the federal government, in the middle of the Depression and a housing crisis, nationalized the mortgage markets by, among other things, creating Fannie Mae as a government entity. Over the following decdades there has been a gradual privatizing of the fed’s role in the mortgage markets. Now, in the middle of the worst housing crisis since the Depression, the markets have been nationalized again.
Did they have to do this? Yes, though you could argue over the timing and the method used. But the current housing market crash, the continued illiquidity of mortgage backed securities (MBS) and all the financial instruments built on top of them, and the growing distrust (especially in foreign markets) in the ability of Fannie and Freddie to withstand continued losses, meant that the federal government would have to use its newly created powers to back them sooner or later and in one way or another.
Could Fannie Mae and Freddie Mac have survived as independent entities, given enough time and the confidence of the markets? We'll never know the answer to this, of course, but unless the housing markets found their bottom this year or early next year, the probability is that the losses the two companies were suffering would have tripped capital provisions that they could not have met. In other words, it looks like the current housing collapse is so unprecedented that it was blowing through the stress models the companies used to determine how much capital they needed.
So what's next? Short term: The focus will naturally be on all the details. The move is without precedent and lawyers, regulators, bureaucrats, and officials at Fannie Mae and Freddie Mac won't be getting much sleep for awhile as they work out new ways to run the companies. The short term focus will also be on pushing money out into the mortgage markets in order to (hopefully) stabilize housing prices.
But what are the long term goals now? Well, this is not a serious problem for the current Administration as they really only need to kick the ball down the field until November (or, to be more generous, through January 2009). There have been suggestions that the conservatorship is only expected to last for a year or so, but without any specifics as to what would be next. So in a year the companies become … what? Independent, stockholder run companies again? Not hardly!
In fact, no one knows what the end game for this move will be, or to be fair could know. The future role of the federal government in the U.S. housing markets is now squarely at issue, a highly political question, to say the least, and a lot will depend on the outcome of the elections this November./p>
The long term future of Fannie and Freddie post-conservatorship will be the subject of a long term debate. Don't, however, expect the companies to simply re-emerge as private companies in a year or two, or ever, for that matter.
Every possibility is now on the table. At one extreme, they could become independent federal agencies or even be merged into HUD or Treasury. At the other extreme, there will be those who advocate simply winding the companies down and closing them, thereby leaving mortgage finance to the private market. Some of the more thoughtful analysts of the matter suggest they be split up and part of them kept by the federal government while another, smaller part be spun off into the private market without federal backing, control or support. Every other possible iteration will be proposed as competing philosophies and politics push and pull.
Hopefully, certain things will be kept in mind as the future of the federal role in housing is debated. One is that there is a federal role. This conservatorship should not be the first step in getting the federal government out of any role in financing homeownership and multifamily housing. When times are good and the markets smooth, there is really only a very limited role for the federal government.
But at least once a decade all hell breaks loose in financial markets and then the only way to keep this turmoil out of the housing markets is for the federal government to step in. Fannie and Freddie have played this role very effectively for 70 years in one way or another, and the fact that they failed this time is no reason for the federal government to abandon the concept of an ongoing presence in the mortgage markets.
Another thing to keep in mind is that homeownership is not for everyone at all times. The rental markets are important to providing housing for the full spectrum of housing needs. The federal government should not try to encourage making too much credit available to the home mortgage markets. Better regulation of mortgage markets and a better balance between owning and renting is essential.
At the heart of the matter is how the federal government and private markets work together in a new, globalized world. The size and importance of the U.S. housing markets makes this an issue of great importance, not only to Americans looking to buy or rent a home they can afford, but to investors around the world who have been financing our housing markets for decades now.
Let's take some time with this one, and think it through. Also, it will be a perfect place for bipartisan efforts. Good housing affordable to all is not a partisan issue, though there are naturally very different philosophies as to how it should be provided.
In the end, it will inevitably take both the government at the federal, state, and local levels along with the private market to achieve this. The shape of this partnership is now wide open.
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