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CBO Studied Privatizing Fannie/Freddie

Believe it or not, the Congressional Budget Office was tasked during the GHW Bush administration in 1992 with studying the feasibility of privatizing Fannie Mae and Freddie Mac.

Four years later, in May of 1996 — during the Clinton administration, they finally published their findings in this CBO Study:


MAY 1996


This report on the desirability and feasibility of privatizing the two largest government-sponsored enterprises (GSEs)–the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac–satisfies part of section 1355 of the Federal Housing Enterprise Safety and Soundness Act of 1992. That statute directed the Secretary of the Treasury, the Secretary of Housing and Urban Development (HUD), the Comptroller General, and the Director of the Congressional Budget Office (CBO) to study the desirability and feasibility of repealing the charters of the GSEs, eliminating federal sponsorship of the enterprises, and permitting them to operate as fully private entities. The legislation directed the studies to address the effects of privatization on costs to the enterprises, cost of capital, home ownership, secondary market competition, capital requirements for GSEs, secondary market liquidity, and other factors deemed appropriate…

Surprisingly, in chapter three of their study, the CBO found that Freddie Mac and Fannie Mae were not so indispensable for low-income home ownership, after all:

Extending Low-Income Home Ownership

The Housing and Community Development Act of 1992 gave the Secretary of Housing and Urban Development authority to establish goals for the housing GSEs that were intended to increase access to mortgage financing for lower-income borrowers.

For 1995, the targets set by the Secretary included:

* 30 percent of units financed for households with income at or below the area median;

* 30 percent of units financed secured by properties in central cities; and

* $4.6 billion (Fannie Mae) and $3.4 billion (Freddie Mac) in mortgages for households with income at or below 80 percent of the area median.

Both GSEs exceeded their income-based targets by a considerable margin, but Fannie Mae barely reached the central-city target (at 30.4 percent) and Freddie Mac fell short (with 23.4 percent). Despite the existence of those goals, most observers agree that the “proportion of mortgages purchased through low-income home ownership programs is low relative to overall GSE conventional activity” and that GSE activity for rental housing is “small” compared with the “size of the market for multifamily lending.”

For 1996, the goal of the central cities has been redefined as a “geographically targeted” goal including rural and other “underserved” areas. That change substitutes a goal that Freddie Mac met for one that it did not meet. That is, both Fannie Mae and Freddie Mac would have met their central-city goal for 1995 had the 1996 goal been in place.

Both housing GSEs are also conducting large consumer education and outreach efforts, including advertisements in multilingual, audio, braille, and computer formats; telephone hot lines; and home-buying fairs. Despite those intense publicity campaigns, a significant contribution by the GSEs to the nation’s affordable-housing goals has yet to be demonstrated. Fannie Mae and Freddie Mac claim that by reducing interest rates on home mortgages, they increase home ownership by all income groups. However, the federal subsidy is responsible for that effect. The housing GSEs are only one of several alternative vehicles for delivering that subsidy. Increased home ownership is not a benefit of using one delivery instrument rather than another…

Thus, in terms of providing the crucial credit-risk service to low-income and minority borrowers, purely private depositories appear to outperform Fannie Mae and Freddie Mac. That result may not be difficult to explain. Fannie Mae and Freddie Mac largely specialize in mortgage finance for first-quality borrowers rather than in assessing and bearing the credit risk for marginal borrowers. The housing GSEs require private mortgage insurance on all loans with a loan-to-value ratio of more than 80 percent and are generally more likely to require private mortgage insurance on conventional mortgages than are depository holders. Their reluctance to bear credit risk may simply reflect that:

Fannie Mae and Freddie Mac, unlike depositories, generally have no interactions with borrowers and are not located in the neighborhoods where the mortgages are originated; thus they lack the opportunity to look beyond traditional measures of risk.

Even though Fannie Mae has announced its intention to acquire another $1 trillion of mortgages for borrowers “who have not been well-served by our housing finance system–families who earn less than the median income in their area, those living in central cities and rural areas, the elderly, immigrants, first-time home buyers, and others with special housing needs,” Fannie Mae apparently does not intend to increase its assumption of credit risk.

The GSE’s chairman has dismissed suggestions that this initiative, “Showing America a New Way Home,” will increase risk at Fannie Mae. Instead, he has said that Fannie Mae will buy mortgages originated to “well-qualified” borrowers. He has also forecast that “loan-to-value ratios are not likely to rise significantly from where they are currently” and that Fannie Mae could adjust price and “would consider further raising mortgage insurance requirements if it became necessary.”

The claim by the housing GSEs that the enterprises deliver social benefits from increasing home ownership by disadvantaged borrowers appears to fail the institutional capacity test.

In chapter four of this study the CBO even notes that Fannie Mae and Freddie Mac would fight tooth and nail against any possibility of privatization — and have in fact been doing so for years:

The Congress and the GSEs: Weak Control and Incompatible Interests

Taking into Account Subsidized Profits and Political Risks

The possibility of privatizing Fannie Mae and Freddie Mac clearly reveals the inconsistency of taxpayer and shareholder interests. For taxpayers and government policymakers, that issue involves weighing costs and benefits in search of efficient, equitable public policies. Changes in the federal relationship with the housing GSEs that would decrease government subsidies and increase public benefits are naturally seen as desirable.

For the shareholders and managers of Fannie Mae and Freddie Mac, however, the possibility of privatization raises the specter of losing more than 40 percent of the firms’ net income. Terminating the federal subsidy and withdrawing the government’s equity position could reduce the market value of the housing GSEs by an equivalent percentage. Clearly, the prospect of such a loss of personal fortune is one of the biggest risks facing investors and senior managers of those companies.

In keeping with its fiduciary responsibility to shareholders and its own financial interests, the management of the housing GSEs has devoted a significant (but undisclosed) portion of the enterprises’ resources to countering–or hedging–that political risk. For example, the two housing GSEs have 12 employees who are registered lobbyists under the Lobbying Disclosure Act of 1995 and a number of political consultants under contract.

Fannie Mae, in particular, makes no secret of its attempts to influence federal policy toward the GSEs as a means of controlling political risk. Those efforts have led one observer to remark that “at Fannie Mae political and financial power are inextricable: bone and sinew, mortise and tenon.” Some of Fannie Mae’s initiatives in the past several years seem aimed at ensuring the flow of federal benefits to the enterprises in perpetuity.

Consider, for example, Fannie Mae’s decision to create 25 Partnership Offices in cities across the country to coordinate with state and local political authorities. Although those offices may conduct some mortgage-related business, their principal function is to enhance Fannie Mae’s political base. In discussing that move, Fannie Mae’s general counsel said: “For a relatively small investment, Fannie Mae will be recognized as a force for good in each of the cities or states. By doing so [Fannie Mae] will have 25 networks of support.” Also, in commenting on the GSEs’ success in defeating a proposed cost-of-capital equalization fee proposed in 1995, Fannie Mae’s general counsel concluded, “the strength of our handling of this issue and others” comes from “building this network and working it over time so that when a franchise issue comes up, our ducks are lined up.” Significantly, too, Fannie Mae explicitly includes the contribution to preserving its “franchise” when evaluating the performance of executive staff.

Those efforts to acquire “political risk insurance” have borne fruit. As Fannie Mae put it in its 1995 annual report: “Policy makers in Washington, DC and throughout the country understand very well that Fannie Mae is a critical part of the success of our nation’s housing finance system. And this has made our franchise stronger than ever before.” One analyst has gone so far as to conclude that “Fannie Mae and Freddie Mac are so large and powerful today that the government probably lacks the ability to compel them to accept privatization if they believe that their interests would thereby be disadvantaged.”

The conduct of the GSEs in this respect is not scandalous or even anomalous. Rather it is entirely consistent with management’s obligation to protect the interests of shareholders. The lawful, but unbridled, advance of shareholder interests at the expense of taxpayers, however, is an essential and inescapable consequence of the choice of GSEs as a means of delivering a federal subsidy to borrowers. It is part of the price of using GSEs as an instrument of public policy. Not least, it is a factor to be weighed in any decision to continue that practice or to end it by privatizing Fannie Mae and Freddie Mac.

These 25 “Partnership Offices” were (and still are) working hand in glove with ACORN, La Raza and the National Urban League to agitate for the continuation and of course expansion of their programs.

Shockingly, the fifth and final chapter of the CBO Study says that, yes indeed, Fannie Mae and Freddie Mac could be readily privatized:

Options for Improving the GSE Cost-Benefit Balance for Taxpayers


Inasmuch as the GSEs are already privately owned, it seems odd to speak of privatization as a policy option. “Restructuring” is the preferred term used by one study. Withdrawing federal sponsorship, or defederalization, is close to the essence of this option. However achieved, this policy would effectively eliminate the implied federal guarantee of GSE debt and MBSs.

Privatization could be undertaken abruptly by repealing the federal GSE charters and all the special provisions of law and regulation that convey the implicit guarantee. A sudden withdrawal of sponsored status–though it would make the decision more difficult to reverse–runs the risk of creating enterprises “too big to fail” and of subjecting the financial system to a shock from changes in the prices of many securities. A more gradual approach could address those difficulties.

One of the thorniest issues facing privatization is the need to win the support of shareholders and management. The magnitude of the subsidy going to those interests makes it unlikely that stakeholders could avoid a loss if federal sponsorship was withdrawn. Accordingly, strong resistance to privatization is expected from the GSEs.

Based on recent experience with another GSE, the Student Loan Marketing Association, policies that reduce the federal subsidy can overcome such resistance. Policies that would produce that result include reducing the size of the loan ceiling for conforming mortgages, imposing a cost-of-capital fee, limiting the ability of the GSEs to issue debt to finance their mortgage portfolios, mandating contributions to a low-income housing assistance fund, and imposing higher capital requirements for shareholders. Those policies could help the owners and managers of Fannie Mae and Freddie Mac to anticipate a net benefit from privatization.

Of course, such options beg a question: why would the GSEs agree to those policies as a first step toward the withdrawal of their subsidy? That admission simply acknowledges that once one agrees to share a canoe with a bear, it is hard to get him out without obtaining his agreement or getting wet. If the GSEs were to support privatization, they and the Congress could certainly carry it out without financial disruption.

So it would seem the CBO thought it was possible to privatize these two institutions. Indeed, technically, it would just be a matter of removing the taxpayer subsidy.

But they anticipated quite a howl from the two GSEs.

The Student Loan Marketing Association did not have 25 community-based Partnership Offices.

The SLMA had not put so many politicians and political groups like ACORN on their payroll — to guarantee their jobs and outlandish profits in perpetuity.

This article was posted by Steve on Wednesday, October 1st, 2008. Comments are currently closed.

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