May 25, 2011

Transparency, Transition, and Taxpayer Protection: More Steps to End the GSE Bailout

Testimony Before the House Committee on Financial Services
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Chairman Garrett, Ranking Member Waters, and distinguished members of the Subcommittee, thank you for inviting me to testify today. I have been asked to offer opinions on “Transparency, Transition and Taxpayer Protection: More Steps to End the GSE Bailout.”

Fannie Mae and Freddie Mac, the government sponsored enterprises (GSEs) in conservatorship, are the dominant players (along with the Federal Housing Administration) in the residential mortgage market, with a market share of more than 90 percent in terms of purchasing and insuring mortgage losses. Given that Fannie and Freddie have effectively crowded the private sector out of the secondary mortgage market, can the private sector offer a less costly alternative to Fannie and Freddie that requires less government involvement in the housing and mortgage markets? The answer is yes.

I have reviewed seven proposals to facilitate a transition from such a dominant role in the mortgage market and limit taxpayer losses. These proposals constitute pieces of the puzzle in trying to deal with Fannie Mae and Freddie Mac in terms of market capture that was accomplished with a government guarantee (whether explicit or implicit).

Currently, taxpayers have provided over $160 billion in “draws” to Fannie Mae and Freddie Mac. One proposal caps the taxpayer loss at $200 billion; this represents a major step towards the curtailment of further taxpayer bailouts of Fannie and Freddie.

A second proposal will require Fannie Mae and Freddie Mac to sell or dispose of assets that are not critical to their missions. This would prevent Fannie and Freddie from accumulating an investment portfolio as well as a retained portfolio. Allowing Fannie and Freddie to purchase nonmortgage investments would be counterproductive to the securitization mission since they would be operating as a financial investor rather than a simple securitizer of mortgage loans.

A third proposal will apply the Freedom of Information Act to Fannie Mae and Freddie Mac while in conservatorship or receivership. One of the problems with Fannie and Freddie was their opaqueness. It was very difficult to understand how risky Fannie and Freddie were until it was too late (and we still do not know the extent of their risk exposure). I would strengthen this transparency proposal to any iteration of Fannie and Freddie, should they survive and return from conservatorship.

A fourth proposal is to terminate the Housing Trust Fund and the requirement that Fannie Mae and Freddie Mac make annual allocations for said Fund. I concur that Fannie and Freddie should have the Housing Trust Fund contribution eliminated since we already have the FHA. I would like to see a full debate on how much as a society we want to contribute to affordable housing goals.

There are three other proposals that are helpful to unwinding Fannie and Freddie and limiting taxpayer exposure to losses. But I would like to take the opportunity to look at the bigger picture in terms of Fannie Mae and Freddie Mac. That is, do we really need them?


There is nothing unique, per se, about Fannie and Freddie that the private sector could not provide. Fannie/Freddie and the private sector have loan-underwriting models, both can purchase loans and create mortgage-backed securities (MBS), and both can offer mortgage insurance. The one attribute that Fannie and Freddie have that the private sector does not is an explicit guarantee from the federal government.

Is this federal government guarantee necessary to entice investors to purchase MBS? I would say no. The original “gold standard” mortgage of Fannie and Freddie was the conforming loan with 20 percent or greater down payment and good borrower credit. The default rates on these mortgages have always been very low (typically less than 5 percent for 30-year fixed-rate mortgages), as has the loss per default. The private sector can handle that segment of the market through private insurance markets and portfolio lending and will continue to attract interest from the global investment community. The “gold standard” conforming-mortgage market does not need a federal government guarantee. If the private sector can replicate Fannie and Freddie’s only unique “virtue”—a federal government guarantee—then there is no justification for keeping Fannie and Freddie around either in conservatorship or in their preconservatorship forms. Fannie and Freddie will not be missed, nor will their absence make a difference to the housing market or the economy, particularly if taxpayers are no longer on the hook for further losses.