A bear, but it’s done.
The White House is throwing cold water on a private investment group’s proposal to recapitalize Fannie Mae and Freddie Mac, the giant government-owned and government–backed mortgage companies.
Investor Bruce Berkowitz of Fairholme Capital Management LLC proposed last week that a group of hedge funds would pump new private cash into the two entities and restore value to their shares. They could then be relaunched as state-regulated bond-insurance companies, and the federal government could exit from its role as owner and exclusive guarantor of most U.S. mortgages. That role is a result of the $188 billion taxpayer bailout of the government-sponsored entities (GSE) following the collapse of the housing market in 2008.
White House economic advisor Gene Sperling, speaking at a conference in Washington, called the idea of recapitalizing parts of Fannie and Freddie and selling them back to investors a nonstarter. The White House backs some aspects of a bipartisan bill -- introduced by Sens. Bob Corker (R., Tenn.) and Mark Warner (D., Va.) -- to replace Fannie and Freddie with a new system offering federal reinsurance for mortgage-backed securities. It would put the up-front risk for guaranteeing mortgage bonds on to private investors, and provide a government backstop for catastrophic losses.
Christopher Mayer, research director at the Paul Milstein Center for Real Estate at Columbia University, explains that a recapitalization plan along the lines proposed by Berkowitz would leave the government holding some of the bag from the housing crisis.
“Fannie and Freddie have a portfolio of troubled loans and past insurance that would be left in the existing entities,” says Mayer. “And they would spin off the mortgage insurance business, the part that involves insuring new loans to homeowners.”
The latter business is now highly profitable -- Fannie and Freddie will send the federal government $39 billion in dividends in December.
Susan Wachter, real estate and finance scholar at the University of Pennsylvania’s Wharton School, says the current situation -- with Fannie and Freddie under government control, dominating the housing market -- is unsustainable and unprecedented.
Wachter says the White House’s opposition to private-investor recapitalization at this point is driven by concern that the same risks and vulnerabilities that existed before the financial crisis, will be perpetuated, “that we can't be in a position to re-do what happened -- issues of 'too big to fail' and a race to the bottom."
Wachter says the White House and bipartisan lawmakers are worried investors might again chase high-risk, high-return real estate bets, with an implicit government guarantee they’ll be bailed out by U.S. taxpayers again in the next crisis.
She says the issue that needs to be settled now is “whether the U.S. taxpayer is willing to provide ongoing, unlimited exposure to all the risks of housing market declines going forward, as opposed to having private capital up front to take the risk.
“That tradition is how we work,” Wachter adds, “private markets taking these risks, managing with government oversight.”