Send a Tweet
Most Popular Choices
Share on Facebook 12 Share on Twitter Printer Friendly Page More Sharing
OpEdNews Op Eds    H3'ed 8/12/13

Fiddling with Fannie and Freddie only sets us up for another crash

By       (Page 1 of 2 pages)   2 comments
Become a Premium Member Would you like to know how many people have read this article? Or how reputable the author is? Simply sign up for a Advocate premium membership and you'll automatically see this data on every article. Plus a lot more, too.
Author 2529
Message Dean Baker
Become a Fan
  (42 fans)
Source: The Guardian

Best leave the mortgage market in government control or abolish Fannie Mae and Freddie Mac entirely and let moral hazard rule


(Image by Unknown Owner)   Details   DMCA
President Obama has said he wants to privatize more of the mortgage market -- but leave in place government guarantees. Photograph: Jason Reed/Reuters

President Obama's announcement of his plans for a restructured mortgage market was painful for those who remember the bubble and crash. It seems as though he learned nothing from this disaster.

The key problem in the bubble years was the ability of private actors to profit by taking huge risks in issuing and securitizing bad mortgages, while handing the downside risk to taxpayers. This was the story with Countrywide, Bank of America, Goldman Sachs, Citigroup and the rest.

It was also the story with Fannie Mae and Freddie Mac in their prior incarnation, before the collapse of the bubble sent them into conservatorship. The pre-conservatorship Fannie and Freddie were run as for-profit companies. Their top executives made Wall Street-type salaries, pocketing tens of millions of dollars a year.

While Fannie and Freddie had been created by the government and ostensibly had a public purpose in promoting homeownership, there can be little doubt that profit figured most prominently in their business strategy. When Freddie decided to jump big-time into the subprime market in 2006 -- just as it was collapsing -- the motive was increasing market share and profit, as this Moody's analysis makes clear.

The moral hazard problem of the pre-crisis Fannie and Freddie -- private profit and public risk -- was eliminated when they went into conservatorship. In the last five years, they have been operated to sustain the housing market, together buying up more than 80% of the mortgages issues since the onset of the crisis.

Given that both are now covering their costs and making profits, which are, arguably, too large even, it's difficult to see what the problem is. But President Obama wants to wind them down and replace them with a new and ostensibly improved public-private system.

While we don't know the details of what the new system will look like, the basic story is clear. Private banks like Goldman Sachs, Citigroup, Bank of America will again issue mortgage-backed securities (MBS). Unlike the MBS of the bubble years, these new issues will carry an explicit government guarantee.

In this new system, there will be a requirement that investors in the MBS absorb some loss before the guarantee kicks in. This is supposed to ensure that they don't game the system by pumping out MBS filled with junk mortgages. And the whole system will be carefully regulated.

Readers can be excused if they are feeling some seriously unpleasant deja vu reading this. Yes, we have seen this movie before -- and we might already be in the second reel.

In the immediate aftermath of the crash, there was a widespread insistence that MBS issuers would have to keep a substantial stake in the mortgages they put into MBS. Some were arguing that they should have to hold 20% of these mortgages on their own books. This quickly got whittled back to a much more modest 5%.

Then, it was decided that high-quality mortgages with down-payments of more than 20% would not require any reserve. The industry decided this was still too restrictive. They lobbied to have the requirement weakened so that issuers don't have to hold reserves against mortgages with as little as 5% down, even though these mortgages defaulted at 3-4 times the rate of mortgages with 20% down in the years preceding the crisis.

Another highlight of the bubble was the gaming of ratings by the credit-rating agencies. It turns out this is back, also. The New York Times reported last week that Standard and Poor's had lowered its standards for rating commercial mortgage-backed securities and had won more business doing so.

Dodd-Frank did have a provision to eliminate this problem. Senator Al Franken (Democrat, Minnesota) proposed an amendment under which the Securities and Exchange Commission (SEC) would select the rating agency rather than the issuer, thereby eliminating the incentive for rating agencies to shop for business with inflated ratings. Even though the Franken amendment passed overwhelmingly, with bipartisan support, the conference committee decided the SEC should study the issue.

After three years, and dozens of industry comments, the SEC issued its report saying that it lacked the ability to pick bond-rating agencies. Therefore, we're back with the same cesspool we had before the crisis.

In short, there is no reason to believe that the current regulatory structure will protect us from the worst abuses of the bubble years.

Next Page  1  |  2

(Note: You can view every article as one long page if you sign up as an Advocate Member, or higher).

 

Well Said 1   News 1   Valuable 1  
Rate It | View Ratings

Dean Baker Social Media Pages: Facebook page url on login Profile not filled in       Twitter page url on login Profile not filled in       Linkedin page url on login Profile not filled in       Instagram page url on login Profile not filled in

Dr. Dean Baker is a macroeconomist and Co-Director of the Center for Economic and Policy Research in Washington, D.C. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University. (more...)
 
Go To Commenting
The views expressed herein are the sole responsibility of the author and do not necessarily reflect those of this website or its editors.
Writers Guidelines
Contact AuthorContact Author Contact EditorContact Editor Author PageView Authors' Articles
Support OpEdNews

OpEdNews depends upon can't survive without your help.

If you value this article and the work of OpEdNews, please either Donate or Purchase a premium membership.

STAY IN THE KNOW
If you've enjoyed this, sign up for our daily or weekly newsletter to get lots of great progressive content.
Daily Weekly     OpEdNews Newsletter
Name
Email
   (Opens new browser window)
 

Most Popular Articles by this Author:     (View All Most Popular Articles by this Author)

The Federal Reserve Board and the Presidential Candidates

The Deficit Hawks Target Nurses and Firefighters

The Attack of the Real Black Helicopter Gang: The IMF Is Coming for Your Social Security

The profit on the TARP and Bernie Madoff

Poverty: The New Growth Industry in America

The Real Reason For The Government Shutdown

To View Comments or Join the Conversation: