TOPICS > Economy

Are Fundamental Changes for Mortgage Giants Fannie, Freddie Ahead?

August 17, 2010 at 8:37 PM EST
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The Obama administration is calling for some fundamental changes at mortgage giants Fannie Mae and Freddie Mac. Jim Lehrer discusses the possible changes with William Poole, former Federal Reserve Bank of St. Louis president, and John Taylor of the National Community Reinvestment Coalition.
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JIM LEHRER: Next tonight: the debate over the government’s role in the housing market and what it could mean for Fannie Mae and Freddie Mac.

Ever since the housing bubble burst in 2008, the fates of mortgage giants Fannie Mae and Freddie Mac, and their problems, have loomed large. Today, the Obama administration called in banking executives and others for advice on the issue. Treasury Secretary Timothy Geithner moderated.

U.S TREASURY SECRETARY TIMOTHY GEITHNER: Fixing this system is one of the most consequential and one of the most complicated economic policy problems we face as a nation. These were avoidable failures, and it is our responsibility to make sure that we create a system that is not vulnerable to these same failures happening again.

JIM LEHRER: Fannie and Freddie are government-sponsored enterprises, GSEs, that operated as private companies. They packaged mortgages into securities, with a guarantee against default.

The goal was to help more Americans afford homes. The companies made huge profits, but when subprime mortgages went bust, they took huge losses, and investors looked to the government to stand behind the guarantees. In September of 2008, then Treasury Secretary Henry Paulson announced a federal takeover.

HENRY PAULSON, former U.S. Treasury Secretary: Fannie Mae and Freddie Mac are critical to turning the corner on housing.

JIM LEHRER: To date, the rescue has cost the Treasury nearly $150 billion. Republicans have charged Fannie and Freddie promoted irresponsible lending, and played a key role in bringing on the recession. Secretary Geithner said today the companies were not the only cause of the crisis, but he pledged fundamental change. Congress didn’t directly address Fannie and Freddie in the new financial regulation law. Instead, it ordered the administration to come up with a reform plan by January, and Geithner called today for help across party lines.

TIMOTHY GEITHNER: The failures that produced this crisis, that produced the system we have today were bipartisan, and the solutions must be as well. This is a test for Washington.

JIM LEHRER: But the shape of any change remains a large question.

Housing Secretary Shaun Donovan:

SHAUN DONOVAN, Housing and Urban Development Secretary: We need to ask ourselves what role the government should be playing in that market. To be clear, the government’s footprint in the housing market needs to be smaller than it is today.

JIM LEHRER: But just how small or big that footprint should be sparked debate today. William Gross runs the largest bond fund, Pimco.

WILLIAM GROSS, managing director, Pacific Investment Management Company: As well, we need the government balance sheet. And to suggest that the private market can come back in and take the place and — and do the same thing that they have done for the past 20 or 30 years is simply impractical. It won’t work.

JIM LEHRER: Alex Pollock is with the conservative think tank American Enterprise Institute.

ALEX POLLOCK, American Enterprise Institute: We need a private secondary market for the bulk of mortgage loans. We should have no GSEs. Fannie and Freddie should no longer be GSEs. You can either, in my view, be a private company or a government agency, one or the other, but not both.

JIM LEHRER: In the meantime, Fannie and Freddie continue doing business. They bought or guaranteed nearly three-quarters of all U.S. home loans last year.

Two further views on this now. William Poole was president of the Federal Reserve bank of Saint Louis from 1998 to 2008. He’s a scholar in residence at the University of Delaware and a senior fellow at the Cato Institute, a libertarian think tank. John Taylor is the president — Cato Institute — sorry about that. John Taylor is the president and CEO of the National Community Reinvestment Coalition, focusing on housing in traditionally under-served communities. He has served on housing advisory boards for both Fannie and Freddie.

Mr. Poole, now, you believe that it’s time to phase out Fannie Mae and Freddie Mac, correct? Why?

WILLIAM POOLE, former president, Federal Reserve Bank of Saint Louis: Oh, absolutely. There seems to be general agreement — and I was pleased that Tim Geithner emphasized this point — they shouldn’t be reconstituted as private entities, with government support in the background. So, the question is, are they going to be perhaps merged into a single government agency to continue doing what they are now doing?

My view is that they ought to be phased out altogether. I think Bill Gross is absolutely wrong in his diagnosis. I note that many other countries have — Western European — Canada, for example, do not have intermediaries like this, and their markets work just fine. So, we can do without them.

JIM LEHRER: We can do without them, Mr. Taylor?

JOHN TAYLOR, president and CEO, National Community Reinvestment Coalition: I love it how folks always refer to Canada when they want to. They also have socialized medicine up there. And they also refer to the U.K. in the same vein, that they have a good system.

Look, no, it’s a long stretch to go from Secretary Geithner’s comment that we can’t reconstitute them the same to totally eliminating them. And this would be bad news for, you know, tens of 50 millions of Americans who now…

JIM LEHRER: Why would it be bad news?

JOHN TAYLOR: Well, because they own their mortgage — they owe their mortgage to the fact that there’s — Fannie and Freddie, for 95 percent of their corporate career, actually did a pretty good job in creating homeownership in the middle class.

And it was — and Mr. Poole in his editorial in The New York Times even says this — it was the free market that kind of led us into this abyss of subprime lending. And Fannie and Mae — Fannie Mae and Freddie Mac followed them. And, as he puts it, they joined the parade, I think is what he says. But they didn’t get in front of the parade to try to stop them. Well, you know, that’s a little unfair, but let’s eliminate them. My question is, do we want to eliminate the free market or Wall Street or investment banks, because they led the parade?

JIM LEHRER: Let’s ask Mr. Poole that.

Mr. Poole?

WILLIAM POOLE: There’s no question that the private market made some terrible mistakes, bears a lot of responsibility for the financial crisis. But I repeat that there are many other examples of markets that work just fine without a government intermediary. A good example would be the automobile market. The banks securitize auto loans. They are sold into that market. The auto loans are, of course, the obligations of households. It works just fine without a government intermediary. I think you would be surprised at how fast the market would fill the gap as Fannie and Freddie are phased out.

JIM LEHRER: Well, what would be — what would be the harm, Mr. Poole, from your perspective, in — in reconstituting Fannie and Freddie in some continued hybrid form?

WILLIAM POOLE: The harm would be that it would be a method, a way of slipping further housing subsidies into the operation of the mortgage market.

We might put some taxes or extra fees, for example, on the securitization. And that would be used to finance other housing programs. If we’re going to have subsidies, they ought to be openly discussed. They ought to be transparent, and they should be enacted by the Congress, not as backdoor fees.

Fannie and Freddie, to my way of viewing it, had a very inglorious history here of campaign contributions and many other practices that were really on the edge of being unsavory.

JIM LEHRER: Well, let’s go back to you on that, Mr. Taylor, on the reverse question. What would be the harm of doing — you say that it would…

JOHN TAYLOR: The harm would be the market.

JIM LEHRER: The market would collapse?

JOHN TAYLOR: Well, look what happened when — when essentially Fannie in fact took a back seat in mortgage lending. From 2001 to 2003, they lost a trillion dollars of market share, a trillion dollars. They — and they lost it to the free market, these folks that Bill has suggested should be the only lender.

And what did they do? What did that free market do? Well, those are the ones who financed no-documentation, low-documentation, piggyback loans, you know, made loans to people who had no ability to pay. It was all about fee-taking. It’s what got us into this mess.

So, the thing is not to throw the baby out with the bathwater. Bring them back, but have the oversight. Make sure they’re adequately capitalized. Make sure they can’t do some of the things that Bill is suggesting. I agree, prohibit them from making political contributions. I would like them to do that with a lot of institutions.

But there’s things we can do to keep the good parts of this market that created a lot of homeownership for a huge segment of our population here in this country, without allowing them to follow any bad actors down any paths that — whether it’s high costs or subprime or predatory lending or anything like that.

JIM LEHRER: Well, Mr. — you mentioned Mr. Poole’s piece in The New York Times. And he feels that — and you — you can say it in your own words, Mr. Poole, but I will put it to Mr. Taylor, that what Fannie Mae essentially — Fannie Mae and Freddie Mac essentially did was use the government to back up the — back up the risk, the government side, and the private side made the money.

JOHN TAYLOR: Yes.

JIM LEHRER: And how do you keep that from happening if you reconstitute or continue Fannie Mae and Freddie Mac?

JOHN TAYLOR: Well, you know, of course, in fact, the charter for Fannie and Freddie are only guaranteed a billion dollars worth of losses. But there was this implicit guarantee that people refer to that the government would back them.

Well, as it turns out, it also will back private financial institutions as well. So, that implicit guarantee, just because it isn’t — doesn’t have a government stamp on the agency, doesn’t mean that the government isn’t going to stand behind you, so that we don’t have a more catastrophic event in our economy.

As far as whether or not — I’m sorry. Your — you…

JIM LEHRER: Well, I mean, that, the way it is now, Fannie Mae and Freddie Mac, the government bails them out.

JOHN TAYLOR: Yes. Right. Absolutely.

JIM LEHRER: But, when they make money, the private side makes money, gets rich.

JOHN TAYLOR: Exactly. So, that was my point about they need to — in the same way that mortgage insurance companies or other kinds of companies, they need to keep a reserve, keep adequately capitalized, so they can deal with any losses that they suffer in the future.

It’s — it’s — all businesses should and do indeed do this. So, there’s no reason that we can’t create reasonable standards for them to hedge against losses. And particularly if you’re keeping them out of really highly risky, unsavory kind of lending practices, and you have adequate capitalization, you can actually have, you know, the kind of system we had seven, eight years ago, before they really got into the subprime market in a heavy way.

JIM LEHRER: What about that, Mr. Poole? Can we go back to that?

WILLIAM POOLE: We shouldn’t mix up general issues of financial reform with where we take Fannie and Freddie. The issue is whether Fannie and Freddie should — should be reconstituted as truly government agencies. I don’t think anybody really wants them to be private agencies. The old system, where the government bears the risk and the private parties get the gains, everyone agrees that that is a rotten system. So, should Fannie and Freddie remain as government agencies, probably merged as a single agency?

And my view is that they’re not necessary. One of the things we don’t seem to talk enough about is that the government is in a terrible fiscal situation. Here is an opportunity for the government to shed some operations at very little cost to the mortgage market. Indeed, I think the mortgage market would benefit.

One of the good ways of looking at this is that the jumbo market, which is — has mortgages above the size permitted for purchase by Fannie and Freddie, the interest rates there traditionally were about 25 basis points above the conforming mortgage rates. And that’s about where they are today. So, already, we see that the private market is — is really quite well-established all over again.

JIM LEHRER: All right. Well, we have to leave it there on this note of disagreement. We will see what happens. Thank you both.

JOHN TAYLOR: Thank you.