Making Housing Sane Again

If you think most equity investors have been in an ebullient mood since Election Day, consider the euphoric owners of Fannie Mae and Freddie Mac. With both stocks soaring more than 130% since Nov. 8, Fan and Fred shareholders are ready to do the Juju on That Beat in the middle of Wall Street. The Trump Administration needs to shut down this block party before it gets out of hand.

The cause for revelry is the expectation that Treasury secretary nominee Steve Mnuchin is going to revive the Beltway model of public risk and private reward. When the Senate Finance Committee hosts his confirmation hearing, likely soon after Inauguration Day, lawmakers should extract a promise that he won’t.

Fan and Fred’s owners feasted for decades on implied taxpayer guarantee before the housing crisis. Since everyone knew the two government-created mortgage giants would receive federal help in a crisis, they were able to run enormous risks and still borrow cheaply as they came to own or guarantee $5 trillion of mortgage paper. When the housing market went south, taxpayers had to stage a rescue in 2008 and poured nearly $190 billion into the toxic twins.

Fannie and Freddie recovered, but only because of this taxpayer backing. Not unreasonably, taxpayers now receive all of their profits. But the private shareholders of these so-called government-sponsored enterprises keep pretending that something other than the government is responsible for their income streams. As if anyone would buy their guarantees – or give them cheap financing – if Uncle Sam weren’t standing behind them.

The hedgies that own Fan and Fred talk about liberating the companies from Washington, but what they really want is to liberate for themselves the profits that flow from a duopoly backed by taxpayers.

And Mr. Mnuchin, the Goldman Sachs alum, seems to be speaking their language. “It makes no sense that these are owned by the governments and have been controlled by the government for as long as they have,” Mr. Mnuchin told Fox Business in November. “So let me just be clear – we’ll make sure that when they’re restructured they’re absolutely safe and they don’t get taken over again. But we got to get them our of government control.”

We’re all for businesses getting out of government control – unless they’re playing with taxpayer money. Americans were told that Fannie and Freddie were safe for years before the last crisis. The right answer is to shut them down.

We were hoping that perhaps the Treasury nominee’s thinking might have evolved since he send Fannie and Freddie shares soaring last year. But on Friday night a Trump transition official gave us a comment similar to the one Mr. Mnuchin gave to Fox in November.

As a former mortgage-backed securities trader, Mr. Mnuchin may try to argue that change would disrupt markets and that reform could deny people a cheap 30-year mortgage. There’s a Wall Street-Washington mythology, expressed recently in a paper from the Obama Treasury, that government backing is an essential element of housing finance.

This is nonsense. As former FDIC Chairman William Isaac and former Wells Fargo Chairman Rickard Kovacevich noted recently in these pages, “Nonconventional or ‘jumbo’ 30-yer mortgages not guaranteed by Fannie and Freddie have existed for decades. In the decade preceding the financial crisis, the interest rate on these jumbo mortgages averaged only about 0.25% higher than similar guaranteed mortgages, a difference of a little over $40 a month on a $200,000 mortgage.”

A 2014 report from the Congressional Budget Office found that rate increases in a private market would likely be smaller than the annual rate fluctuations in the government-backed market today.

Speaking of the government-backed market, there are still more threats to taxpayers over at the Federal Housing Administration. Fan and Fred’s cousin that is part of the Department of Housing and Urban Development. The housing industry is hoping HUD Secretary Julián Castro will deliver one more subsidy boost on his way out the door by announcing lower premiums on federal mortgage insurance.

Mr. Mnuchin can show that the Trump Administration is charting a new course by rejecting the old model of housing finance that created a financial crisis and still endangers taxpayers.

Will Trump protect taxpayers or Fannie and Freddie shareholders?