There was a tremendous panel discussion today in the U.S. Senate hosted by the Federalist Society. The discussion concerned the proposed Corker-Warner bill to “reform” the housing finance system. The moderator was Troy Paredes and the speakers included Ronald Case, Bernard Weinstein and myself.
Going forward, what should happen to the mortgage giants Fannie Mae and Freddie Mac? Weinstein argued that they should be kept in place, but regulated to avoid Congress from forcing them to take on too much risk. Case gave an eloquent discussion of the necessity for the rule of law in whatever happens going forward.
Bear in mind that Corker-Warner takes two huge mortgage insurance companies (duopoloy) and replaces them with one GIGANTIC government insurance company (monopoly). I don’t get how a government monopoly improves the plight of America’s shareholders: the taxpayer.
What did the rule of law come up as a topic? Fannie Mae and Freddie Mac are in conservatorship with taxpayers owning 80% their stock. Other investors own common stock, preferred and and debt. Under a liquidation (proposed under Corker-Warner), taxpayers and other investors property rights are violated since they will receive potentially mere pennies on the dollar in a liquidation. A bankruptcy like Chrysler is the preferred way to handle any Fannie Mae, Freddie Mac wind down, not liquidation.
Governments often have trouble with the rule of law. Municipalities across the US are beginning to use eminent domain to seize mortgages that rightfully are the property of investors who are entitled to the cash flow from ownership. Bond holders in the General Motors bailout were paid a mere pennies on the dollar compared to what they would have received in bankruptcy. Treasury has changed the terms ex-post on the cash flow from Fannie and Freddie, claiming any profit for the government rather than non-government shareholders. And the list goes on.
Whatever Congress decides on the future of Fannie Mae and Freddie Mac, it is important to realize that GSE liabilities (such as guarantees) were actually HIGHER than the Federal debt outstanding prior to 2009. If Fannie and Freddie are put back in the private sector, someone is going to have absorb those liabilities. And that someone is the US taxpayer.
So, there are investors in Fannie Mae and Freddie Mac to protect and taxpayers to protect, a tricky high-wire act for Congress. While Fannie and Freddie are “profitable,” unleashing them into the market without reform would be dangerous. The best way, of course, would be to put them into bankruptcy. But that would result in almost a doubling of US debt outstanding.
How do we let ourselves get into this mess? Answer? By using off-balance sheet tactics to avoid confessing staggering government liabilities. It is best to come clean and recognize the magnitude of the promises the government has made and try to correct it.
I am leaving out much of the debate. But it was most interesting. And Corker-Warner should really pay more attention to investors and taxpayer rights. After all, who will fund the US mortgage market if we keep harming investors and taxpayers with rule changes or failing to follow the laws already in place?