Holman Jenkins wrote an excellent editorial for the Wall Street Journal last week, arguing that the U.S. Government should privatize F&F, sell off their underwriting offices to private investors, and force America to join the rest of the capitalist world in the way its mortage apparatus works.
I couldn’t agree more, but for slightly different reasons.
Fannie Mae was founded in 1938 as part of FDR’s new deal. The idea was to provide liquidity to a housing market that was stuck in neutral as a result of the Great Depression. The reasoning of the moment was that there would be no incentive for builders to add to the nation’s housing stock if no one had the liquidity to purchase, and there could be no buyers if there were nothing to buy.
In 1968, Fannie was separated from the government’s balance sheet iamidst the swirl and uncertainty of the war in Vietnam. It made its debut as a publicly traded company some years later and in 1970, Freddie Mac was founded to provide increased competition in the secondary market for mortgages. Freddie also became a public market debutante in 1989. *check)
Beyond the kickstart provided for the housing market in the 30s, F&F have become increasingly anachronistic. Their basic business model is to charge their customers a guarantee fee, standing behind the assets they package because presumably (although not explicitly), the U.S. Government stands behind them. This even though the OFHEO, which regulates F&F, allows them to operate with considerably less capital than would be required of an arms-length business of a similar size.
Said simply, F&F existed to provide cheaper mortgages than would otherwise be offered by private banks. As long as those loans didn’t go bad, everybody was happy: homeowners got cheaper loans (although how much cheaper is the source of some debate), and shareholders and management got rich by brandishing the government shield but never having to use it. Which brings me to what I’ve never understood about F&F: much if not most of the of the value of the taxpayer guarantee flowed to F&F shareholders and management, not back to the average taxpayer. At its peak, the combined market capitalization of the two entities was north of $150 billion. And has been well documented, F&F executives earned compensation packages on par with other large financial inistitutions which had no similar taxpayer backstop.
Much has been made of charges of cronyism surrounding the two agencies. And, for most of this decade, one or the other of F&F has been enmeshed in some sort of questionable dealings on accounting, executive compensation, and conflicts of interest. But the real force behind their perpetuation seems to have been the desire of politicians from both parties to promote home ownership as an anchor of the American dream. President Bush is only the latest of our leaders who trumpets the virtues of an “ownership society,” conveniently leaving out the fact that in a time of plummeting asset values, a “leaseholding society” looks pretty good.
Now, the result of the orgy that F&F encouraged has eliminated the two organizations’ reason for being. Along the way, the language was always quaint: F&F were “providing needed liquidity” to the U.S. housing market. The problem with that sort of liquidity is that it is need is in the eye of the beholder. Management and shareholders certainly “needed” it to become considerably wealthy by driving loan volume. The housing market, not so much. The more loans were issued, the more homes were built. The more homes were built, the more subject housing the market was to Depression-esque correction which has characterized the last three quarters. And of course with the decline in asset values comes an even more severe decline in the value of the loans collateralized by those assets.
Recent U.S. Census data puts this all in sharp relief. There will be about 4 million more households with children in 2025 than there were in 2000. But more than 10 million new single-family homes have already been built since 2000, most of them in the suburbs. With housing stock in tremendous oversupply, it’s hard to see what unique purpose F&F serve going forward, regardless of what means Congress and the various regulatory agencies choose to unwind the current mess.
In 1938, taxpayers made a deal that, as a society, they were willing to be exposed to risk so that houses could be built and bought. That is a referendum that would fail miserably today. And if that’s true, it seems that Jenkins’ proposal is a wise one. And more importantly, the idea of selling more F&F equity to the public and leaving current management to do what they will with it seems positively loony. F&F management and stockholders should exclusively bear the pain of the decline in F&F’s balance sheet. Of course, beyond that the Feds step in, but only beyond that.
The Financial Times published a brief history of F&F here: