In the past five years western finance has generated plenty of eye-popping statistics. For my money, though, one of the most bizarre sets of numbers involves American housing.
A decade ago about 40 per cent of new US mortgages carried implicit government backing, since these loans were guaranteed by entities such as Fannie Mae and Freddie Mac. Even then this pattern looked odd, given that Washington and Wall Street espouse a free market creed.
But today it is surreal. Private banks have become so reluctant to make loans that more than 90 per cent of new US mortgages now carry government guarantees. Meanwhile, Fannie and Freddie – which between them own or guarantee about $5tn worth of mortgages – remain trapped in a quasi-nationalised state after being rescued by the Treasury in September 2008.
The good news is that Congress is now finally trying to address this situation: on Tuesday a Senate committee is expected to approve a reform bill. Better still, this legislation commands bipartisan support, from a Republican senator (Mike Crapo) and a Democratic counterpart (Tim Johnson).
The bad news is that radical change seems unlikely. Opinions on Fannie and Freddie remain deeply split. The Crapo-Johnson plan, for example, proposes to put housing finance on a more sustainable footing by using a hybrid approach that both preserves a government guarantee and introduces more market discipline. Thus it would transfer Fannie and Freddie’s operations to smaller, competing institutions; tighten mortgage underwriting standards; improve regulatory oversight; and force private investors to swallow the first 10 per cent of losses on mortgage bonds. This, it is hoped, will enable America to retain its liquid market for “safe” mortgage bonds, and keep attracting inflows from foreign investors – delivering the cheap 30-year fixed mortgages that middle class Americans consider a God-given right.
But many Republicans hate the idea of more government backstops. Thus a separate bill in the House of Representatives demands an end to Fannie and Freddie. And just to make matters more complex some Wall Street investors holding Fannie and Freddie shares, issued before nationalisation, are lobbying to keep the housing giants alive – but as well-capitalised, private-sector bodies. This campaign is driven by self-interest: if Fannie and Freddie stay alive, as profitable private entities, existing shareholders could enjoy big future payouts; if Crapo-Johnson reforms are passed, this is unlikely, since any profits will probably be passed to the Treasury.
Given all these divergent, messy interests, most Washington observers do not expect the Crapo-Johnson bill to advance beyond the Senate banking committee this year. And some Wall Street investors are so confident it will die a quiet death they are gobbling up the housing giants’ shares: the activist investor Bill Ackman, of Pershing Capital, for example, raised his stake in Fannie to above 11 per cent.
These investors are betting that housing reform will stall. It will be a tragedy if they turn out to be right. In the short term, a cynic might suggest there is little need for change. After all, the status quo suits many consumers fine. (Moody’s estimates that interest rates on 30-year mortgages would jump almost 2 percentage points from their current level of 4.5 per cent if government subsidies were suddenly removed.) It also benefits the Treasury: Fannie and Freddie have recovered so well they are paying the government significant dividends which bureaucrats are furtively using to plug some fiscal holes.
But the problem with quick crisis-fighting “fixes” is that they have a habit of becoming addictive, creating new distortions and sowing the seeds of the next crisis.
As it stands, the Crapo-Johnson bill is certainly not the perfect remedy for Fannie and Freddie; it is excessively complex, and contains political gimmicks. But it is not nearly as dismal as the status quo. And if the Senate committee does advance the bill, this will at least force some proper debate about the peculiarities of the current system. Five years after the crisis this is long overdue; not least because nobody can possibly claim to have “fixed” American finance after the 2008 crisis while this $5tn eyesore is still being swept under the carpet.
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