Taxpayers shouldn’t be asked to pay for Fannie and Freddie’s risk exposure

Published in The Hill.

As the old Washington saying goes, “When all is said and done, more is said than done.” This certainly applies to the years of congressional debates about how to reform Fannie Mae and Freddie Mac. They are dominant forces in the huge American mortgage market, operating effectively as arms of the U.S. Treasury.

Can you ever protect the taxpayers against the risk of Fannie and Freddie? In their current form, with virtually zero capital — and soon literally zero capital — they are and will continue to be utterly dependent on the taxpayers’ credit card for their entire existence. Every penny of their income depends on the credit support of the taxpayers.

Since 2008, Fannie and Freddie have been a $5 trillion risk turkey, roosting in the dome of the Capitol. The members of Congress are unhappy and greatly irritated by its presence, but didn’t know how to get rid of this embarrassment their predecessors created.

Of course, even before their humiliating government conservatorship, Fannie and Freddie traded every minute on the credit of the U.S. Treasury and were always were a risk to the taxpayers. Although in those days they had some positive capital of their own, it was not very much capital relative to their risks. Without their free use of the taxpayers’ credit card, they would have been much smaller, much less leveraged, much less profitable and much less risky.

Once the Congress had set up Fannie and Freddie as government-sponsored risk takers, was there any way to remove the taxpayers’ risk exposure? The historical record offers little hope. No matter what any Treasury secretary or any other politician says, or even what any legislation provides, the global debt markets will simply not believe that two institutions representing half of all U.S. mortgage credit and sponsored by the U.S. government will not be bailed out by the Treasury. And the debt markets will be right.

In 1992, while revising the legislation that governs Fannie and Freddie, Congress solemnly tried to wiggle out of the problem. It added to the statutes of the United States a provision entitled, “Protection of Taxpayers Against Liability” for Fannie and Freddie’s debts. This “protection” is still on the books, although it did not provide any protection to the taxpayers.

Title XIII, “Government-Sponsored Enterprises,” of the Housing and Community Development Act of 1992, Section 1304, pronounced:

This title may not be construed as obligating the Federal Government, either directly or indirectly, to provide any funds to the Federal Home Loan Mortgage Corporation [Freddie], the Federal National Mortgage Association [Fannie], or the Federal Home Loan Banks, or to honor, reimburse or otherwise guarantee any obligation…

But naturally, when push came to shove in the housing-finance crisis, the federal government, directly and indirectly, did fully honor, entirely reimburse and effectively guarantee all the obligations of Fannie and Freddie anyway.

The statute went on to say:

This title may not be construed as implying that any such enterprise or bank, or any obligations or securities of such enterprise or bank, are backed by the full faith and credit of the United States.

Nice try, but no cigar. All the bond markets in the world knew that this fine language notwithstanding, all Fannie and Freddie’s obligations were in fact backed by the credit of the United States, as they still are and will continue to be.

What do you suppose the members of Congress who wrote and voted for those provisions were really thinking? Did they foolishly imagine that Fannie and Freddie could never actually get in financial trouble? Were they simply cynical, knowing that their provisions would not in fact protect the taxpayers? Or did at least some members of Congress truly believe they were doing something meaningful? One wonders.

The “protection of taxpayers” included in the 1992 act obviously failed. Can Congress avoid taxpayer risk from Fannie and Freddie next time? It seems unlikely in the extreme. But you might take a number of steps to reduce the inevitable taxpayer risk, including much higher capital requirements for Fannie and Freddie than heretofore, and charging a meaningful fee for the use of the taxpayers’ credit card, which will cause them to use it less.

There is one additional key lesson: government-sponsored enterprises, if they are created, should never, never be given perpetual charters like those given to Fannie and Freddie. If they were instead given limited life charters, say for 20 years (like First and Second Banks of the United States), Congress could at least periodically consider whether it would like to end the taxpayer risk game by not renewing the charter.