State of GSE'S And What Will Uncle Sam Do with Its Sick Children?

It would be easier to solve a Rubicks cube with one hand than trying to predict the future of reform for Fannie and Freddie.


When the troubled twins were not included in the financial reform bill, the American taxpayer was told by Secretary Geithner the Administration would "develop a comprehensive reform proposal" on the GSEs. Now it Congress' turn to pick up the task and they're making a September Splash.

The month of September is going to be a busy one for the Representatives with three separate GSE reform hearings ending with a crescendo with Chairman Barney Frank's hearing on the 29th. The first hearing titled" The Future of Housing Finance: A Progress Update on the GSEs" was chaired by Rep. Paul Kanjorski (D-PA).

I had a chance to ask both Kanjorski and Rep. Spencer Bachus, Ranking member of the Financial Services Committee their outlooks on the GSEs and what needs to be done to them. I am breaking down my C-Suite Insider into two separate interviews. Here's my dialog with Rep. Bachus:

LL: What were the biggest take always out of the hearing?

SB: It is clear that the Democrats have no intention of acting to reform Fannie Mae and Freddie Mac. In fact, Chairman Frank said this morning if Congress ends its session one week early, it will keep them from introducing GSE legislation.

This is a continuation of the Bart Simpson defense the Obama Administration uses on every issue— “I didn’t do it.” It is clear the current majority does not want to change the GSEs.

They like them just as they are regardless of the risk to American taxpayers. This is one of the most important issues before the Financial Services Committee, and I think it’s very important for us to get started on GSE reform right now.

LL : Do you have any concerns over the Affordable Advantage program?

SB: It’s disturbing that we have programs like Affordable Advantage, along with the state financing authority, where there's no down payment required, and there is no good credit history that is required.

In fact, people are getting mortgages under this, and other Fannie and Freddie programs, without any down payment. So if housing prices go down — and who knows whether they will or not — you are actually creating more mortgages that taxpayers may one day have to pick up.

In fact, when asked about this program, FHFA Director Ed Demarco said that “this one got away from us.” This program is yet another reminder that the attitudes and policies that led to the failure of Fannie and Freddie have not changed. That’s why it is important that we begin the process to unwind Fannie and Freddie now.

LL: St. Louis Fed President and CEO James Bullard is calling for breaking up the GSEs into "regional companies" so the market could be open to the private players and restructure their operating incentives. Do you think that is a good option?

SB: Seemingly, this would be to replicate the Federal Home Loan Bank model. It’s certainly worthwhile to create competition in the secondary market.

However, as you know, the GSE experiment of "public mission, private ownership" on which Fannie and Freddie were built must be judged for what it was: a failure that has left us with a weakened financial system, a surfeit of unsustainable mortgage debt, an oversupply of housing, and an open-ended commitment the Administration has undertaken to pay off those who fueled the housing boom, all at the expense of the American taxpayer.

We cannot break up the GSEs only to transform them into regional companies with exactly the same problem, with an added geographic risk.

LL: When will we see a cogent strategy plan for the GSEs with so many homes underwater?

SB: There is a plan. House Republicans first introduced a bill in July 2009 to end their bailout and begin the process of winding these institutions down. Republicans have six bills dealing with the future of Fannie Mae and Freddie Mac. I’ve asked Chairman Frank on numerous occasions to schedule a legislative hearing on our bills and he has refused.

LL: How do you think the GSEs should be reformed?

SB: House Republicans want to reinvigorate the housing finance system in a way that does not rely on government guarantees, that does not make private investors and creditors wealthy while saddling taxpayers with losses, and that does not set the stage for the next financial crisis. Leaving the secondary mortgage market to a lot of competing private participants is the best policy option.

Republicans will create a private, competitive market that would price mortgages according to risk, be more innovative and efficient, and operate with less political interference. That process can’t start until Fannie and Freddie are reformed to eliminate their taxpayer supported subsidies that drive out private capital.

LL: What incentives should be put in place to help the private market become an innovative source of mortgage financing?

SB: The government cannot create incentives. What you need to do is get the federal government out. The private market cannot compete with a taxpayer subsidized entity. I would say that government ownership and management squeezes out private actors.

If the government is out, I am confident that private actors will fill the space. This was confirmed today during the hearing, when FHFA Director Ed Demarco said he was confident a private secondary mortgage market is "achievable."

LL: How do we address the "too big to fail" problem? Will a liquidation facility be formed for large financial firms?

SB: An enhanced bankruptcy is the way to address “too big to fail.” In the House Republican proposal for financial reform, which I introduced in July 2009, we set up an enhanced bankruptcy proceeding for the resolution of insolvent non-bank institutions — no matter how large or systemically important.

Bankruptcy is a fair and transparent process to unwind insolvent companies. Our proposal was a clear alternative to the failed and often politicized policy of rescuing "too big to fail" institutions that Democrats institutionalized.

LL: Do you believe the government should include this debt in their overall budget figures?

SB: The Administration is hiding the true cost of Fannie and Freddie’s bailout by keeping the operations of GSEs off of the federal budget. This off balance sheet accounting gimmick is similar to the accounting shenanigans that Greece engaged in for decades.

In order to achieve a fair and honest accounting of Fannie and Freddie’s bailout, the Administration should place these two companies on budget. This is the least the Democrats should be able to do since there seems to be no end in sight for their bailout and the Administration continues to use these two companies to fulfill their social agenda and their failed housing programs.

Taxpayers deserve to know where their dollars are going, what risks they are being exposed to, and how these institutions are being managed or mismanaged. Budget gimmicks cannot be used to cover this up.

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Lori is a Talent Producer at CNBC, and author of "Thriving in the New Economy:Lessons from Today's Top Business Minds."