It appears we are living through a period of historical records. For those of you living in this area, we have managed to get through most of the coldest winter on record. We are also close to the record for snowiest winter as well. Closer to my usual topic, the current economic expansion is closing in on becoming the longest economic expansion in history, but one of the mildest recoveries since the Great Depression. The current expansion began 10 years ago, following the worst of the Great Recession, and if the economy continues to expand, as expected, this summer we will set the record.
Even though the Great Recession can be viewed through a rear view mirror, there are still a few remnants that we are dealing with. As that financial crisis unfolded, the federal government intervened and placed Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation), into conservatorship. The Feds placed $187 billion of capital into these and required their earnings to be paid directly to the U.S. Treasury. There they sit, 10 years later, still operating and their business has become a source of income for the government, with cumulative dividend payments now in excess of $100 billion of the capital injection they received.
Fannie Mae started in 1938 from a New Deal program to support home sales by purchasing mortgages from lenders. By 1970, the bundling of mortgage loans into securities had taken off and Fannie Mae became a private company. The government created Freddie Mac to compete with Fannie Mae. As the market for mortgages increased, so did these agencies’ importance. Beginning in the 1980s, mortgages stopped being long-dated assets held on bank balance sheets. Mortgage-backed securities (MBS) allowed mortgage originators to bundle them and resell mortgage securities to investors. The agencies guaranteed the performance. Although the agencies were private institutions, they had credit lines from the U.S. Treasury and many investors assumed they were backed by the federal government. A number of regulatory and legislative changes helped to make mortgage financing available to more consumers by these government sponsored entities (GSEs). Maybe a little too much, given the excesses just prior to the financial crisis of a decade ago. The GSEs started to carry more of the mortgage debt on their books, entered areas beyond their initial charters, and operated with low capital levels. When the financial crisis occurred, these agencies were at risk of failure. To avoid a collapse of the mortgage markets, the government intervened, to stabilize the mortgage markets and keep the MBS market alive.
Ten years later and there are calls to put this behind us and move these agencies back into private hands. There are some obstacles to this however. The GSEs have not rebuilt their capital to a level of safety, as all the net income has been repaid to the government as dividends. The shareholders of these private concerns have filed lawsuits, yet to be resolved. There are issues with their prior governance structure being continued and allowed to recreate risks that were systemic to the entire financial system. Changes are required to prevent this. Finally, the government may not be so willing to give up this revenue stream and voters may be hesitant to approve actions to deregulate the housing market with the crisis still fresh in their minds.
There has been discussion of exiting the current situation. A number of proposals, both from the administration and Congress, call for privatization of the agencies’ functions. This may promote more competition from a larger pool of private concerns, reducing costs in a more competitive market and reducing systemic risk of market concentration. But, without explicit or implicit government backing, or insurance provided by Fannie or Freddie, costs might increase to reflect higher risks associated with these types of assets. Any benefits or costs would likely be passed along to the consumer, mortgage borrowers.
It may be time to put this aspect of the financial crisis behind us. The housing and mortgage markets have mostly recovered, returning to a healthier phase. With the initial goals of the government intervention achieved, it may be time to implement reform to avoid past excesses and put this market on a more sustainable path.
David Helscher is a senior vice president and trust officer with Clinton National Bank.