Keep Guardrails in Place
There are many good ideas that can be used to ensure that ending the conservatorships have limited impact on interest rates. No one wants to launch the Titanic and create a need for another massive bailout.
First up is Capital, which is the first line of defense in enabling the GSEs to meet their obligations.
Current GSE capital of $150 billion is three times the pre-crisis level of roughly $50 billion, and current capital requirements and retained earnings will take this number even higher over the next few years.
With more capital at the GSEs, there should be no doubt the GSEs are safe, sound, and strong with fortress balance sheets.
Treasury Department
Next, the Treasury Department currently provides an explicit backstop of $244 billion total for Fannie and Freddie standing behind their internal capital to provide additional comfort to the market. Those backstops should remain in place, though Fannie and Freddie could be required to pay an annual fee for that additional protection.
The mortgage credit risk the GSEs stand behind is much lower than in the financial crisis, with an average loan-to-value of less than 50%. In other words, housing prices would have to fall by half for Fannie and Freddie to suffer significant losses.
The Dodd-Frank law got rid of “exploding loans”, liar loans, and the worst subprime mortgages, and the large debt-fueled securities portfolios were shrunk early in the conservatorships. In other words, larger capital amounts support less mortgage risk, and this means lower rates.
In addition, Fannie and Freddie can and should be released as ultra-stable “public utilities” with consent decrees limiting them to delivering returns to investors of 8 to 12 percent annually.
If the returns are higher, the Treasury Department would get the overage as an additional cost for the backstop and to disincentivize Fannie and Freddie from chasing higher returns. The GSEs will be made more stable than ever before, a “widow and orphan” stock paying steady modest dividends in good times and bad.
While these are some of the potential guardrails that can work, the alternative of requiring an explicit guarantee for Freddie and Fannie would blow up the national debt by trillions of dollars, require Congress, and is unnecessary.
It is really just a poison pill pushed by those who want to keep Fannie and Freddie under government control.