Santelli: Protect Taxpayers From Mortgage Losses

The message I heard after November’s midterm elections was that a more fiscally conservative Congress would take power in January and deal with many of the issues that have been kicked like tin cans down the proverbial road. One of the thorniest of those issues is the much-needed reform of mortgage behemoths Fannie Mae and Freddie Mac.

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Serving our country in this particularly trying time in history takes courage and conviction. Our country needs leaders that can make very tough, and in many instances, unpopular choices.

It reminds me of one of my favorite definitions of great leadership, from former First Lady Rosalynn Carter: “A leader takes people where they want to go. A great leader takes people where they don’t necessarily want to go, but ought to be.”

A major test of the mettle of the 112th Congress should be to reform the government-sponsored enterprises (GSEs), Fannie and Freddie. I vividly remember the Treasury's 2009 Christmas Eve surprise when the balance sheet restraints on the GSE’s were removed, putting the American taxpayer directly on the hook for hundreds of billions of dollars of losses.

So my ears perked up when I heard CNBC's Diana Olickinterview former Assistant Secretary of Treasury Michael Barr, currently a professor at the University of Michigan and one of the architects of the Obama Administration's housing bailout. Barr is also a CNBC contributor.

When asked whether the Administration would “keep Freddie and Fannie or eliminate them,” Barr said the election outcome made the process more political, and in his opinion there would be "a lot more emphasis on what needs to happen in the transition period and a much longer time fuse on actually reforming the institutions in the Congress."

He was also asked whether the institutions would be privatized and the current explicit federal guarantee dropped. He answered that he would still want a guarantee but different than the current one.

"I think that if it were up to me I would go ahead and come come out strongly and say we need to continue to have a federal government guarantee. One that's very different than what we've had in the past. One that's explicit. One that's fully paid for. One that doesn't benefit private shareholders, and one that's only really about catastrophic losses in the event we have the kind of financial and housing crisis we've just gone through," he responded.

Barr notes that his idea may not be adopted by Treasury. It's one view of many, but still, the idea of a government backstop remains.

This notion of a Federal guarantee, even with the qualifiers put forth by Barr, in my opinion elevates the moral hazard associated with any federal backstop. The possibility of the catastrophic losses he mentioned should be borne by private companies and the investors and shareholders who choose to invest in them—not taxpayers.

I understand that these are Barr’s personal opinions and may not be the ultimate direction the Treasury will take in its report at the end of the month. However, his past involvement with the Administration gives his words more weight and may be an early indication of what may be in the Treasury Department's GSE reform plan.

I picked up the phone and called several traders, posing the following question. "What trade would you put on if the privatization of the GSE’s ends up being 'kicked down the road?'” The answers were all fairly straight forward: "Sell the long bond and buy mortgages."

As of the close Thursday, the U.S. 30-year bondclosed at the highest yield since April, 2010. The current coupon Fannie Mae 30-year versus the Treasury spread closed virtually unchanged, but still tighter than where it began trading in 2011.

I understand there are a lot of moving parts in the credit markets at the moment. Yet, the markets have always been a good weather vane for the winds in DC.