Like almost nobody I know, I love secondary market mortgage securitization. It got a bum rap during the Great Recession, but its failings were in the execution, not the concept. All secondary market securitization means is that banks (or other lenders) make mortgage loans, then someone else buys up those loans, packages them up, and sells them to investors, thus freeing up banks and other lenders to make further mortgage loans.
Everybody wins, right? Borrowers get their loans and their homes, banks get big fees for making the loans, intermediaries make money buying up and selling the loans to Wall Street, and investors make money over the long term as those mortgages are paid back.
The problem, of course, is the secondary market field was regulated with all of the skill of Barney the Dinosaur performing brain surgery. That led to the collapse of the economy in 2008. Two of the biggest players in the fiasco were organizations known as Fannie Mae and Freddie Mac, and their corporate lives could be about to change big time.
If Fannie Mae and Freddie Mac sound like an overly cute aging couple hopelessly stuck in time — perhaps still trying to organize wild neighborhood parties and keep the music going long after most people want to go home or just talk quietly in a corner — that’s not a surprise. Fannie Mae is the professional name, if you will, of the Federal National Mortgage Association, created during the Great Depression to replace short-term mortgages with longer-term mortgages (between 20 and 25 percent of the country’s mortgages were in default in 1933); Freddie Mac is the stage name for the Federal Home Loan Mortgage Corporation, which was created in 1970 to expand the secondary mortgage markets.
Fannie and Freddie are not lenders. They work with lenders via various finance programs, and they buy up vast quantities of mortgages, package them up, and sell them to buyers on the secondary market. They are involved in about $5 trillion worth of mortgages.
Trillion with a “T.”
Both Freddie and Fannie are government-sponsored enterprises (GSEs), which means they were created by the U.S. Congress and, though they are public companies — their shares were traded publicly on the stock market for decades — they have an “implicit guarantee” the federal government will bail them out if their investments go bad.
The administration of President George W. Bush tried to rein in Freddie and Fannie. Their fear was the two GSEs were getting too involved — and over-leveraged — in the go-go commercial mortgage markets, resulting in not only the crowding out of competitors that lacked the lower costs because of the implicit guarantee (which at least theoretically reduced their risk) but also insufficient investment in the very cause that necessitated their creation: affordable housing.
The reason for the implicit guarantee was to give the two companies the ability and incentive to boost affordable housing. We here in San Francisco can understand that. It is horrendously expensive to develop anything in San Francisco; recent reports have shown the per-unit cost of developing a unit of affordable housing in the city is $750,000. That puts it out of reach of the zillions of nonprofits and churches and other do-gooder groups across the country that are often the developers of housing for low-income groups.
A couple years ago, I was interviewing a San Francisco official and noted not only the difficulties and huge costs of developing affordable housing in the city but also the added costs that get piled on as everyone and their grandmother can delay a project for seemingly any reason whatsoever, and he responded with — silence. The cost of developing affordable housing in this city simply is not going to decrease or be significantly assisted by our city government.
But what about that fun couple Freddie and Fannie?
Oh, we own them. Literally. Like General Motors, Fannie and Freddie were taken over by the U.S. government (to varying degrees) as a result of the Great Recession, when the world economy was pushed off a cliff by the out-of-control U.S. mortgage market.
As hard as it might be for some Democrats to admit, the Bush administration was correct; the GSEs were part of a big problem of bad loans, insufficient regulation to make sure the bundles of mortgages were described properly, and a general “don’t ask, don’t tell” attitude that prevails when everyone’s making big money. As hard as it might be for some Republicans to admit, secondary market mortgage securitization only needs sufficiently stringent regulation to make sure it works. It needs to make sure investors really know the quality of the loans that are in the bundle — even bad loans have buyers — they just need to know the risk going in and price it accordingly.
A GOOD WORD ABOUT TRUMP?
Due to the rampant corruption, bullying, migrant children in cages, white nationalist rhetoric, and other outrages, I would normally be the last person to say something nice about the Trump administration. But here goes:
They might be on to something regarding Fannie and Freddie. The Trump administration has proposed removing the implicit guarantee, except in extreme cases (presumably such as the implicit meltdown of the world economy). That would put the risk in perspective.
A bipartisan team of U.S. senators has proposed a similar change to the GSEs’ status, and big bankers have applauded. But National Community Reinvestment Coalition CEO Jesse Van Tol told Bloomberg the GSE’s “are more profitable, more stable, and better-regulated than at any point in history. But GSE reform without an affordable-housing mandate is not reform — it’s retreat.”
O.K., I take back my good word.