The Future of Fannie and Freddie: Chief Says Government Ownership Is Bad

The Future of Fannie and Freddie: Chief Says Government Ownership Is Bad

Speaking at an annual conference of real estate editors, James Lockhart, head
of the Federal Housing Finance Agency, said on Thursday the government
shouldn’t run Fannie Mae and Freddie Mac. Lockhart should know. He leads the
agency that has been doing just that since last September, when the giant
mortgage insurers were put into government conservatorship. Lockhart said
his experience with Fannie and Freddie as well as helping to run other
government insurance programs taught him that government ownership for
these types of companies doesn’t work.

“What I have seen is that government insurance programs are high-risk,” said
Lockhart. “It is often difficult in a political environment to calculate or
charge an actuarially fair price.” It is essentially a moral-hazard
argument. Lockhart believes that the government will never be able to accurately
price the guarantees that Fannie and Freddie offer mortgage lenders and
investors. And as long as the government is offering that insurance too
cheap, banks will be encouraged to make loans they shouldn’t. And that
will lead to more losses for Fannie and Freddie down the road.

If the bottom lines of Fannie and Freddie are any guide, the government
seems to be doing a less than stellar job with the two mortgage-financing
giants. In the first three months of this year alone, Fannie and Freddie
lost a combined $33 billion; the government has pumped $85 billion in equity
into the two companies to keep them afloat. What’s more, the Treasury and
the Federal Reserve have purchased more than $700 billion of Fannie and
Freddie mortgage securities. Still, the turnaround of the two companies is
not yet in sight. Lockhart said the bottom lines of Fannie and Freddie
probably won’t rebound for another year or two.

Now that the White House has laid out its plans for financial regulation,
figuring out what to do with Fannie and Freddie may be the next task at
hand. This week President Obama said he plans to have a proposal on
what to do with the mortgage insurers by early next year. Fannie and
Freddie, which guarantee to pay lenders and investors in the event that a
borrower defaults, were set up by Congress. But while they were run as
private companies, it was long understood that if the companies ran
into trouble, the government would step in to save them, which is exactly what
That ultimately left the job of turning around the two troubled giants to
Lockhart, who was formerly the chief operating officer of the Social
Security Administration. He says he meets with senior executives of both
companies once a week; his staff interacts with Fannie and Freddie every day.
Lockhart believes that the government has done a better job of running Fannie and
Freddie than the bottom lines of the two companies suggest. Most of the
losses suffered by the mortgage giants, he notes, resulted from mortgages that
Fannie and Freddie backed before they were taken over. Furthermore, part of
the mandate of the current conservatorship has been to use Fannie and
Freddie to stabilize the mortgage market and reduce foreclosures. Fannie and
Freddie now back nearly 70% of all the mortgage loans made this year, a sign
that the two companies have been active in helping people get new loans or
refinance existing ones. And mortgage rates, though up recently, are down from where they
were when the companies were taken over, a further indication that their
added liquidity is helping. Foreclosures continue to rise, but the
government’s latest plan to modify mortgages seems to be making some

Still, for the long haul, Lockhart thinks it would be a bad move to
permanently nationalize the two firms. Instead, he prefers returning them to the private market, perhaps in the form of something close to a
public utility that would charge a fee to homeowners or lenders to subsidize
lower mortgage rates.

Congressman Paul Kanjorski, a Democrat from Pennsylvania who heads up the
House of Representatives subcommittee that oversees Fannie and Freddie,
backs a plan that would break up the firms into as many as 15 smaller
companies. As with public utilities, he thinks the government could regulate
what these firms could charge and how much they could make. That would limit the
risk-taking and excess use of leverage that caused the two firms to
collapse. “I think it would be bad for the mortgage market to get rid of
them completely,” said Kanjorski, who also spoke at the
conference on Friday morning. “But if they were smaller, perhaps next time
we won’t be in the situation where these firms are too big to fail.”
Others think at least some portion of Fannie and Freddie may need to be
nationalized. Congressman Barney Frank told the same group of reporters that
it might make sense to nationalize the duties of Fannie and Freddie that
have to do with promoting affordable housing. The job they do of supporting
the mortgage market could be returned to the private sector. “The two roles
should be separated,” says Frank, a Democrat who heads the House Financial
Services Committee.

Lockhart, for his part, agrees that a breakup may be the answer. But no
matter what is done, Lockhart believes that fixing Fannie and Freddie is
essential to fixing the real estate market. In his speech, Lockhart said,
“It is crucial that we get the restructuring done right for all present and
future homeowners and renters.”