Today the House Committee on Financial Services will hold a hearing titled “A Failure to Act: How a Decade without GSE Reform Has Once Again Put Taxpayers at Risk” to mark the ten year anniversary of the financial crisis. The title off that hearing could not be more appropriate. At the heart of the crisis were the two Government-Sponsored Enterprises (GSEs), Fannie Mae and Freddie Mac, which fueled the growth of subprime mortgages and encouraged people to purchase homes they couldn’t afford. After defaults skyrocketed and the bottom fell out, the GSEs needed a lifeline and went to Congress looking for a bailout. As a result the government placed them into conservatorship and infused them with $187 billion in taxpayer funds.
Policymakers never intended for conservatorship to be the permanent solution, but after 10 years taxpayers remain mired in a pit of potential liabilities for future losses.
Taxpayers should be concerned about the current state of the GSEs, as they have recently been engaging in type of activity that got them into the mess they’re in now. As a result of these disturbing developments, today’s hearing should focus on the dangerous encroachment of the GSEs upon the private market, charter creep, unilateral action absent congressional authorization, and an overall lack of transparency.
While there is only a slim likelihood of any comprehensive housing finance reform legislation becoming law in the short term, we hope the committee will highlight these topics:
A return to risky behavior: Now that the GSEs have an explicit taxpayer guarantee, there is little stopping them from participating in risky behavior. The moral hazard created by a situation where the GSEs reap the rewards while others make up for any losses is massive. As it stands, the GSEs are allowed to purchase mortgages from borrowers who have a maximum debt-to-income (DTI) ratio of 43 percent; however, the GSEs have begun acquiring mortgages with DTIs closer to 50 percent.
Charter creep: The GSEs operate in the secondary mortgage market, but their recent activity suggests that they are willing to compete against private firms in the primary market. Mission creep is evident in the launch of Freddie Mac’s new Integrated Mortgages Insurance (IMAGIN) pilot program, which shares the risk of low down-payment mortgages with private investors. Concerningly, IMAGIN gives favored treatment to some insurers who do not have to follow the same standards as private market actors normally follow in order to do business with Freddie Mac.
Risk sharing with private insurers: While the FHFA should be commended for their transfer of risk from the shoulders of taxpayers to private investors in 2013, much more work remains. The additional $49 billion that recently shifted to private investors amounts to only 1 percent of the GSEs’ holdings. Worse yet, these assets are generally among those of the least risk in the GSEs’ portfolios, leaving taxpayers with some of the more precarious positions.
Lack of transparency: Because GSEs are taxpayer-backed, the leaders of these entities have a special responsibility to ensure financial resources are spent efficiently, this is why NTU has consistently highlighted the soaring costs of of Fannie Mae’s extravagant new headquarters. In fact, an OIG report questioned whether these purchases are “appropriate for an entity in conservatorship.” Taxpayers also deserve to have all programs subject to an open public comment period, so they and other stakeholders can raise concerns and offer improvements. Take, for example, the IMAGIN program, which was not subject to a public comment period, and has revealed very few details about its operations or capital standards. The potential for a future taxpayer bailout -- due to lack of information that could allow less drastic remedies -- is therefore greater.
While public officials engage in meaningful debate on the proper path to long-term reform, in the meantime, basic transparency, oversight, and limitations on the GSEs’ missions are fundamental to protecting taxpayers from poorly crafted policy and wasteful spending.