New York Fed researchers are starting to worry that Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) will eventually be re-privatized if the gridlock over legislative GSE reform keeps up, according to the staff report (meaning it’s not the FRBNY’s official position) The Rescue of Fannie Mae and Freddie Mac.
“Delay prolongs the uncertainty over the government’s future role in residential mortgage finance, which in turn is a deterrent to private capital re-entering the market, and makes the government’s role appear more difficult to replace. Delay also raises the likelihood that deeper reform will be judged as too difficult to accomplish, and raises the risk that the conservatorships are ended by returning Fannie Mae and Freddie Mac to private status with only minor changes to their charters,” they write. “This would be a colossal missed opportunity to put U.S. residential mortgage finance on a more stable long-term footing.”
NY Fed’s five objectives for a successful GSE bailout
The paper sets out five objectives that the researchers say the Fannie Mae and Freddie Mac bailout should achieve if it’s going to be judge a complete success. The first two objectives, continuing the core business of guaranteeing and securitizing mortgages and continuing to honor agency debt and mortgage backed securities, were a major part of the government’s overall plan to hold financial markets together during the financial crisis. Placing Fannie Mae and Freddie Mac in conservatorship achieved both of these short-term goals, though putting them receivership probably would have as well.
Third, the NY Fed researchers say that the bailout should have been designed to wipe out common and preferred stock positions to reflect Fannie Mae and Freddie Mac insolvent position at the time and enforce market discipline. They also argue that subordinated debt shouldn’t have been completely shielded from losses. This would have happened if the GSEs had been put into receivership, and the NY Fed paper seems satisfied that this was done retroactively by thefull income sweep. For Fannie Mae and Freddie Mac shareholders that position is controversial, but probably not much of a surprise coming from one of the Federal Reserve banks.
NY Fed describes Fannie Mae, Freddie Mac conservatorship as a time out
It’s the final two goals that the NY Fed researchers are worried about. They would have liked Fannie Mae and Freddie Mac to be managed as policy tools, meant to help achieve specific macroeconomic goals instead of maximizing the private value of their assets. They give the example of principal reduction as something that could be done to supportdistressed homeowners, and the housing market generally, but hasn’t been pursued at least partly because it would reduce the value of GSE assets.
But it’s the last objective that’s really interesting for Fannie Mae watchers: the structure of the bailout was supposed to act as an impetus for reform.
“The structure of the conservatorship agreements essentially placed Fannie Mae and Freddie Mac in a ‘time-out’,” they write. “The thinking was that conservatorship would force Congress to address the problems of this business model, or else face the long-term prospect of government control of the U.S. housing finance system.”
Seven years into the conservatorships, it’s clear that we aren’t looking at a brief ‘time-out’. With likely presidential candidates (and one official candidate) already campaigning, we’re probably more than a year away from anyone seriously trying to drive GSE reform through Congress again, and that’s what has the NY Fed so nervous. The longer we go without a viable alternative, the easier it looks to tweak the GSEs charters and return them to private status instead of having a nasty political fight over something that most voters stopped thinking about a long time ago.