Diary

How to Stop the Next Fannie Mae Bailout

As Congress and the Trump administration look at reforming Fannie Mae and Freddie Mac, there’s one principle that must undergird the discussion: we cannot return to the era of privatize gains and socialized losses.

For decades, Fannie and Freddie, the so-called government-sponsored enterprises (GSEs), operated under the implicit backing of the government. Although technically private, the market expected Uncle Sam to come to the rescue if needed.

During the 2008 financial crisis, that belief was tested and confirmed. As a result, the owners of the GSEs got to keep the profits they had earned largely as a result of the government’s implicit backing and avoid the losses that occurred when the going got tough.

Eight years later, the GSEs remain under government control, a situation that isn’t ideal or even sustainable in the long term. But a well-funded lobbying campaign is afoot to push “recap and release” – for the government to relinquish control without any reforms, allowing the old rules to come back until the government has to bail out Fannie and Freddie the next time.

The saying goes, “those who don’t learn from history are doomed to repeat it.” In this case, we have people who learned from history and are hoping to doom us to repeat it.

Enough is enough: the GSEs can’t go back to the bad old days. If we’re going to let them exit the government’s control, it should be with clear new rules that ensure taxpayers never have to finance another rescue plan.

Although there’s been much talk of how incoming Treasury Sec. Steve Mnuchin will address the GSEs, the fact is that, under current law, only Congress can enact the types of reforms that are necessary.

As legislation comes together, lawmakers should look at replacing the government’s implicit backing of the GSEs with explicit capital and insurance requirements to cover potential losses. This is the most important reform because it ensures that any future losses are private – not socialized.
There’s a variety of ways to write rules that protect taxpayers and the market from GSE losses that pose a systematic risk to the market.

Second, the new rules should allow other companies to compete with the GSEs. If we create a walled-off garden for Fannie and Freddie to operate in, it will stifle innovation and lead to the same situation of privatized gains that benefit from government policy.

Third, the correct model for the GSEs to emerge from their bailout is as a strictly-regulated utility. It’s too late to truly put the genie back in the bottle, the global financial market over the last several decades has evolved with the GSEs performing a unique and crucial role.

With that understanding, it follows that Congress should outline detailed rules for how the federal government would ever intervene in the future, given a systematic financial crisis. Although strict new capital requirements will greatly mitigate the risks, it’s too late to ever say “never again” and have the market believe us.

The best we can do is set very clear rules for any future intervention that ensure there’s no golden parachutes for executives while taxpayers foot the bill.

The role of the government in such a situation should be extremely limited to only providing market liquidity, allowing a functioning market during any crisis.

In 2008, taxpayers were burned when the GSEs needed a bailout. In good times, Fannie and Freddie had made a killing, but the losses ended up on our tab.

It’s time to privatize these companies under strict rules that limit government rescue in all but the most dire circumstances and then outline exactly how such an intervention would occur in a very limited way.

In the meantime, Fannie and Freddie should operate under close supervision and other participants should be allowed to enter the same markets.

“Recap and release” is catastrophically irresponsible. Lets put some rules in place to make sure it’s never again our problem when someone, somewhere made a disastrous miscalculation on highly complicated and leveraged mortgage speculation.