Paul McMorrow

Rips in the mortgage blueprint

By Paul McMorrow
February 18, 2011

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THE OBAMA administration has finally said what it wants to do with failed mortgage giants Fannie Mae and Freddie Mac. The administration’s plan is as heavy on capitalism as Washington Republicans and banking lobbyists could have hoped for. The Treasury Department has said that the government should not dominate the mortgage business. Treasury wants to bury Fannie and Freddie and return housing finance to the private sector.

The Treasury blueprint on Fannie and Freddie answers what had been the biggest unanswered question of the financial crisis, and it comes down solidly on the side of business. Big banks more or less got their wish. The government-sponsored mortgage giants, which muscled in on banks’ territory and ate away at their profits, are officially goners. The question now is whether the mortgage business will accept the costs of owning the mortgage market.

There are still some details in the Fannie and Freddie wind-down for Congress to haggle over. It’s yet to be determined just how small the government’s role in the housing market should be — whether, as some hard-liners in the House have demanded, Fannie and Freddie get put down quickly and the mortgage market goes private with a cold turkey diet, or whether there will be some triggers that allow for surgical government interventions when credit crises hit.

But those are small arguments, given the extent of government’s current entanglement with the housing market: Fannie and Freddie have already cost taxpayers $150 billion, and the feds currently back more than nine out of every 10 new mortgages. The Treasury blueprint realistically says shutting down Fannie and Freddie tomorrow would have catastrophic effects on a fragile economy, but it’s also clear in its intent to hand private players 85 percent of the housing finance market as quickly as practicable.

So far, so good. Then comes the bargaining part of the Fannie and Freddie extermination plan, which is essentially a grand bargain with the private mortgage industry.

Washington bureaucrats are more than willing to hand private players the keys to the mortgage business again, so long as those private players assume the risks inherent in the mortgage business. That proposition will likely ignite the fiercest battles of the Fannie and Freddie fight.

The government’s mortgage exit plan is built on robust oversight of the private mortgage market. Many of those oversight mechanisms have yet to be written and implemented, and are targets in House Republicans’ efforts to limit the reach of the new Dodd-Frank financial reform package. They include rules on mortgage costs, complexity, and disclosure, and mandates that banks retain more capital and hold on to small slices of the mortgage bonds they sell.

These common-sense oversight measures owe as much to the Fannie and Freddie meltdowns as they do to the havoc bad mortgages caused on Wall Street. Fannie and Freddie took huge risks on bad mortgages. The two companies’ shareholders reaped rewards, but the risk was borne by taxpayers. It’s an extreme illustration of what happened across the financial system — companies divorced profit from risk. The post-Fannie and Freddie mortgage regime will demand that risk and reward be linked again.

That’s a bigger request than it seems. The institutions that made easy money during the housing bubble did so by pushing mortgage risks on others. Big banks didn’t have to worry about whether a mortgage would blow up in three years, because they weren’t left holding the bill. That will change under still-unwritten Dodd-Frank regulations — regulations big business has fought bitterly.

The Treasury blueprint makes these regulations a condition of Obama’s Fannie and Freddie exit strategy. But the regulations are under fire from House Republicans. Spencer Bachus, chairman of the committee overseeing Dodd-Frank’s implementation, recently said he’ll review pending Dodd-Frank rules in light of their impact on jobs.

Bachus has said he believes the Volcker rule, which prevents banks from gambling with cash borrowed from the Federal Reserve, is a jobs killer. He has even made noises about broad-reaching financial regulations being unconstitutional. So it’s not difficult to divine how he views the oversight that would follow Fannie and Freddie’s exit. The impulse to weaken new mortgage regulations should be fought at every turn. The demise of Fannie and Freddie should breed capitalism, not ruthlessness and anarchy.

Paul McMorrow is an associate editor at CommonWealth magazine. His column appears regularly in the Globe.