US agencies: Mortgages monsters on collision course

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Something has to give. Fannie Mae and Freddie Mac - America's colossal home mortgage securitizers - have been growing at about 11.5% per year. That's much faster than the market they serve: the underlying market for home mortgages in America is growing at only about 6% per year.
So, Fannie and Freddie are going run into a problem, not very far down the road. Peter Wallison, a resident fellow at the American Enterprise Institute, and Bert Ely, an American banking consultant, estimate that Fannie and Freddie are on track to assume the credit risk for almost half the residential mortgages in America by the end of 2003. And Fannie and Freddie will have acquired all the mortgages available within a short time after that.
"The question then will be how can Fannie and Freddie get out from under the government's thumb so that they can continue to grow," says Wallison. Fannie and Freddie, two government-sponsored enterprises (GSEs), will need new powers from Congress in order to branch out into other businesses before they run out of assets they are permitted to buy. Failing that, their growth will come to a screeching halt and their stock prices could plummet. Wallison and Ely published their results in Nationalizing Mortgage Risk, a new study from the American Enterprise Institute in Washington.The reverberations from what happens to Fannie and Freddie could spread far beyond America's mortgage market. "The government securities market, as we know it today, is a GSE market," says Frank Cavanaugh, now retired, formerly a senior official at the US treasury in charge of domestic finance. Cavanaugh points out that the GSE market is twice as big as the market for US treasury securities. And he estimates that foreigners hold just under 10% of all GSE securities.In case anybody forgot, the US is on track to retiring all treasury debt held by the public before the end of 2013, if the official forecasts are correct. The US Budget Office predicts that government trust funds will own $6.8 trillion of treasury securities by then. But there probably will be a lot of government deficits after that as the baby boomers retire. Cavanaugh is one who thinks that it would be very costly for America to allow its treasury market to wither away, only to be forced to recreate it a little bit later. So, he wants the giant Social Security Trust Fund, along with other government trust funds to start buying lots of GSE paper as substitutes. It's an increasingly familiar debate to governments around the world as they move into surpluses. It may sound appealing to operate with zero debt, it may even become possible if surpluses persist, but is it prudent? Might it not be wiser to maintain certain outstandings of debt in order to maintain market access and instead cut taxes. In America, there are concerns about the status and privileges of the GSEs and a growing debate about whether they should be fully privatized and their federal subsidies reduced. US Federal Reserve chairman Alan Greenspan sent a letter to congressman Richard Baker on May 19 noting that Fannie and Freddie benefit from a federal subsidy that was worth $6.5 billion per year, according to one study, in the mid-1990s. That figure would be larger today. Fannie and Freddie's shareholders retain about one-third of the subsidy, rather than passing it through to homebuyers. The bottom line: the Fed is reviewing its use of GSE securities in open market operations.Large purchases of Fannie and Freddie paper by the Fed, as well as by government trust funds, would shift more risk to taxpayers and probably raise the value of the subsidy. But risk-shifting, despite all the heat that it generates in Washington, doesn't seem to be fueling the current debate. Federal Reserve economists have published evidence that Fannie and Freddie don't take very much credit risk. And Fannie and Freddie spend quite a bit of their gross revenues to pass risk on to others in the marketplace. Presumably, those investors understand what they are buying. The real reason why there's such a hotly contested debate about Fannie and Freddie's future is their unbridled growth together with the enormous economic and political power that has come with it. Critics are alarmed because there doesn't seem to be anything in the system - not in Congress, the executive branch, independent regulators, and certainly not from private competition - capable now of limiting that growth.For their part, Fannie and Freddie argue with almost missionary zeal that they are doing something extraordinarily useful. The US federalized its mortgage markets in the 1930s, they say, and that's not about to change. The country wants long-term fixed-rate mortgages and that's a risky business. The risks accrue to the US treasury and ultimately to taxpayers. Edward Golding, a senior vice president at Freddie Mac, has been making the case at Washington conferences that Fannie and Freddie do a better job of managing those risks than any of the alternatives - particularly institutions covered by deposit insurance.So, what to do? The Federal Home Loan Banks - another in the GSE family - are hankering for more powers, based on the claim that new competition would force Fannie and Freddie to pass more of the subsidy through to home owners. The government, on the other hand, could levy a new tax to reclaim the part of the subsidy that shareholders now grab. Others want to peel away Fannie and Freddie's special privileges, one by one, until there's nothing left. In their sights are the GSEs' $2.25 billion line of credit from the US treasury, Fannie's and Freddie's exemptions from state and local taxes, their unlimited borrowing authority at subsidized rates as well as the individual ceiling on Fannie and Freddie mortgages - now at $225,000 - above the median home price. Still others think that regulation, based on stronger laws, could do the job. The ultimate choice for many reformers, of course, is true privatization.

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US agencies: Mortgages monsters on collision course

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