The Wall Street Journal
By: Nick Timiraos
July 6, 2011
A California Republican is set to introduce a bill as soon as Wednesday to merge Fannie Mae and Freddie Mac and restructure the company into a government-held corporation.
It's the latest idea in what figures to be a long, high-stakes drama over what to do with the mortgage giants whose government takeover has put taxpayers on the hook for $138 billion to keep them afloat and stabilize mortgage markets.
The legislation, sponsored by Rep. Gary Miller, will propose that the merged company purchase mortgages and sell them to investors as securities that are government backed. It wouldn't be operated for profit-making purposes and wouldn't have shareholders, effectively returning it back to its New Deal-era roots, before Fannie Mae was privatized and sold off to shareholders in 1968. It's expected to win backing from bond investors and the real-estate industry.
The debate on what to do with the companies has inched along since February, when the White House called for winding them down and offered three options that would take their place: One would leave the private sector to fill their void, and two would create some new type of government backstop.
House Republicans have embraced the first option and are opposed to any new guarantees. They have advanced a series of bills to shrink Fannie and Freddie's reach. "It was that sort of support that got us into the financial crisis we're in right now, and we don't want to go down that road again," said Rep. Scott Garrett (R., N.J.). But Mr. Miller, a real-estate developer and former home builder, predicted that his bill would attract significant bipartisan support. "You're going to be shocked at how many Republicans will support this," he said in an interview.
The bill, co-sponsored by Rep. Carolyn McCarthy (D., N.Y.), is the latest to underline both parties' qualms with a fully private market. In May, two lawmakers--one Republican and one Democrat--introduced legislation that would replace Fannie and Freddie with at least five private companies that would issue mortgage bonds with explicit federal guarantees.
Mr. Miller's proposal differs because it wouldn't seek private owners for the new utility-like entity, though he says it should be privately capitalized. Banks would pay a "guarantee" fee on loans that would fund the firm's operations and maintain adequate capital. Investors would pay an additional fee to finance an insurance fund that would cover catastrophic losses.
A five-member board would govern the corporation. It would be regulated by the Federal Housing Finance Agency, which would ensure that its market share didn't exceed 50% of the mortgage market.
The corporation wouldn't be permitted to amass a gigantic mortgage portfolio, as Fannie and Freddie did, and instead would focus primarily on guaranteeing mortgages that meet certain standards.
Still, critics worry that such public utilities could be too easily influenced by presidents, lawmakers, and special interest groups. "There's too much room for political interference," says Anthony Sanders, a real-estate finance professor at George Mason University.
Skeptics also worry that government guarantees will ultimately result in taxpayers taking on too much risk. "Markets will find a way to work within the letter of the rules so that the largest risk gets concentrated in the government," says Arnold Kling, a former Freddie Mac economist who supports eliminating government guarantees.
Still, Mr. Kling says reconstituting Fannie and Freddie with better regulation and more capital "frightens me a lot less than trying to come up with a new scheme" to backstop loans.
Fannie and Freddie were taken over by the government in 2008 as rising mortgage losses wiped out thin capital cushions.
Mr. Miller blames the firms' collapse on management decisions to satisfy shareholders' appetites for big returns. He said lending standards were relaxed to take market share from Wall Street firms that had ramped up securitization of subprime mortgages. "We're trying to create a system [that] eliminates the incentive to go fight for market share," he said.
He said his bill would also prevent the nation's largest megabanks from taking over the secondary mortgage market because the government corporation would allow smaller lenders to sell mortgage loans on the same terms as bigger banks.
Reps. Miller and McCarthy plan to push for the legislation Thursday alongside the heads of the National Association of Realtors and the National Association of Home Builders.
The new corporation would assume the assets and liabilities of Fannie and Freddie and would continue to pay the Treasury dividends that are owed as part of its bailout. Those payments would cease once the company had repurchased nearly $162 billion in preferred shares that are held by the Treasury. The bill doesn't outline how that would take place.
Many industrialized nations don't have institutions like Fannie and Freddie and instead rely more heavily on their banking systems to fund mortgages. But the U.S. government has had a hand in its housing-finance system since the Great Depression. Fannie and Freddie guarantee half of all $10.4 trillion in mortgage debt outstanding and together with federal agencies are responsible for backing around nine in 10 new mortgages.
One of the key questions is how much capital banks and other investors will deploy for mortgages without a government guarantee, on what terms, and at what price. "There's just no getting around it. There's not enough private capital to meet the demand for mortgage credit" without raising borrowing costs sharply, says Mahesh Swaminathan, senior mortgage analyst at Credit Suisse.
Mr. Sanders counters that prudently underwritten loans with down payments of at least 20% to 25% don't need a guarantee. "They only need the guarantee if they're going to embark on low down payments," he says. "That's where the debate gets stalled."
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