Posted on 09/15/2009 3:31:15 AM PDT by Man50D
A Government Accountability Office report says that privatizing the government-sponsored enterprises (GSE) Fannie Mae and Freddie Mac could mitigate the systemic economic risk caused by the federal government’s guarantees to the now-defunct mortgage giants, but that the benefits of privatization could be reversed by government efforts to insure private-sector mortgages.
“The extent to which privatizing or terminating the enterprises mitigates current safety and soundness and financial stability risks is difficult to determine,” said GAO.
“Under one scenario, such risks would be mitigated because large and complex enterprises, which might engage in risky business practices due to the implied federal guarantee on their financial obligations, would not exist,” the report concluded. “Instead, private lenders would be subject to market discipline and consequently would be more likely to make credit decisions largely on the basis of credit risk and other market factors.
“However,” GAO continued, “this scenario would be complicated if a federal entity were established to insure mortgage debt. If the federal mortgage insurer did not set appropriate premiums to reflect the risks of its activities, then lenders might have incentives to engage in riskier business practices than otherwise would be the case.
“In similar situations, such as the National Flood Insurance Program, federal agencies have faced challenges in establishing appropriate premiums to compensate for the risks that they underwrite,” said GAO. “If large private-sector financial institutions assumed responsibility for key enterprise activities or purchased a significant portion of their assets, the perception could arise that the failure of such an institution would involve unacceptable systemic financial risks. Therefore, markets’ perceptions that the federal government would provide financial assistance to such financial institutions could undermine market discipline.”
The report, issued Thursday and circulated to key members of Congress, examined three competing proposals for the fate of Fannie Mae and Freddie Mac: Make them full-fledged federal agencies; keep them as GSEs; or privatize them.
While the GAO does not make policy recommendations, it did examine the positives and negatives of each option, weighing how well each option might achieve federal mortgage lending policy against the risks to taxpayers should something go wrong.
Making Fannie and Freddie pure government agencies, it said, would be the most direct route toward achieving federal policy. In that scenario, however, the government might not be able to manage the task of securitizing millions of mortgages, possibly exposing the taxpayers who would have to pay for any losses the agency incurred.
“Nevertheless, successfully managing a large conventional mortgage purchase and MBS [mortgage-backed securities] issuance business still may be a complex and challenging activity for a government entity,” the report says.
“[T]he failure to adequately manage the associated risks could result in significant losses that could be the direct responsibility of taxpayers,” it says.
If this new government mortgage company were to do as Fannie and Freddie have done and continue purchasing and securitizing mortgages during economic slowdowns, the risk to taxpayers would be amplified because poor economic conditions would make mortgage lending much more risky.
“This risk may be heightened if a government entity were expected to continue purchasing mortgages and issuing MBS during stressful economic periods when the potential for losses may be greater than would otherwise be the case.”
Keeping Fannie and Freddie as they are, the report found, would also allow the government to pursue its goals. However, keeping Fannie and Freddie as government-backed corporations would do nothing to address the problems which helped cause the current recession.
“When mortgage credit markets stabilize, the enterprises as reconstituted GSEs might be expected to perform functions that they have performed for many years,” it says. However, “[c]ontinuing the enterprises as GSEs could present significant safety and soundness concerns as well as systemic risks to the financial system.
“In particular, the potential that the enterprises would enjoy explicit federal guarantees of their financial obligations, rather than the implied guarantees of the past, might serve as incentives for them to engage in risky business practices to meet profitability objectives.”
Privatizing Fannie and Freddie would make it very difficult for the federal government to pursue housing and mortgage policies which favor one group--usually low-income borrowers--the report finds. This might not be a bad thing however, since Fannie and Freddie lost massive amounts of money on just those types of loans.
Fannie and Freddie “embarked on aggressive strategies to purchase mortgages and mortgage assets with questionable underwriting standards. For example, they purchased a large volume of what are known as Alt-A mortgages, which typically did not have documentation of borrowers’ incomes and had higher loan-to-value ratio or debt-to-income ratios.”
These Alt-A mortgages “served targeted groups” according to GAO, but also accounted for massive losses eventually covered by American taxpayers.
“Alt-A mortgages accounted for nearly half of Fannie Mae’s $27.1 billion in credit losses of its single-family guarantee book of business in 2008.”
Privatization, the report suggests, could prevent such a thing from happening again.
“This option also could eliminate the traditional legislative basis for requiring that they facilitate the flow of mortgage credit serving targeted groups, particularly through the numeric mortgage purchase program.”
Who would want to buy into Fannie and Freddie?
“Gee...numbskulls, isn’t that what we’ve been saying all along. It is the government interference that caused the crash, the government regulations that required “target groups” had to have loans, etc..... “
April, 2001: Pres. Bush advocated oversight of Fannie and Freddie. He said, in essence, that it would lead to disaster if they continued as they were going. Bush reiterated this statement 13 times while he was president. Congress, led by Barney Frank and Charles Schumer refused to act. Zero, as usual, did not vote.
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