No institution or group of institutions should be held more accountable for the current financial crisis in America than the Government Sponsored Enterprises (GSEs) with the endearing names of Fannie Mae and Freddie Mac. And it is long past time that we put these culprits out of our misery.
Management of long term mortgage debt is too important to the U.S. economy (and thus the world’s economy) to leave in the hands of two entities that make up less than one per cent of the Fortune 500 companies in America. Although supposedly sponsored by the Government, Fannie Mae and Freddie Mac never worked for the Government, nor did they ever serve the general welfare of the American public.
As private companies, whose stock is still being bought and sold on the New York Stock Exchange, Fannie Mae and Freddie Mac were out to make money for themselves and their stockholders. By manipulating mortgage rates to their advantage, lowering credit standards, holding their own securities funded by ultra-cheap treasury debt, and trading on inside information, the two GSEs intentionally strategised on ways to increase mortgage debt beyond reasonable means.
Because of the oligopoly-like control over mortgage lending given to the GSEs by Congress (and conceded by the Federal Reserve), mortgage debt in the U.S. grew nearly three fold from $2.8 Trillion to $10.2 Trillion in the fifteen-years between 1992 and 2007 (See Exhibit). This growth in mortgage debt grew larger and faster than the better known National Debt which grew from $4.1 Trillion to $9.0 Trillion during the same time period.
In truth, without the housing bubble collapse, there would have been no bank bailouts, no Lehman bankruptcy, no Countrywide failure, no Fed lending, no AIG (the list could go on and on). And if you are looking for the people most responsible for the housing bubble, then that leads you right to the front doors of Fannie and Freddie.
If it had not been for the self-serving business strategies of the GSEs’ to increase debt and keep housing prices escalating for their own company gains, the housing bubble that caused the recession would never had occurred in the first place. And even though GSE Executive Management may not have intended to create a global financial crisis with criminal intent in mind, that same management must still be held accountable for the global financial crisis none-the-less.
Either through ignorance or a need to satisfy their own personal greed, the GSEs mismanaged their power over mortgage rates and their underwriting systems for nearly a 30-year period going back as far as the early 1980s. And no one should overlook the fact that the GSEs regularly used inside information to purchase their own securities prior to selling the remainder to unsuspecting global investors, thus enhancing their bets on how their securities would pay down over the counter bets of those unsuspecting investors.
Now here is the solution to our current dilemma about what to do with the GSEs.
Abolish Fannie Mae and Freddie Mac. Replace them with a much smaller and more conservative government agency modelled after that of Ginnie Mae. Ginnie Mae (with less than 80 government employees) managed the risk of its MBS programs better than the GSEs. In fact, this little guy, unlike the GSEs who have now accrued more than $200 billion in losses since 2007, managed to make money during the same time period.
Put some respected financial person in charge of the new Federal entity, not some “political hack”. Treat this position like you would when choosing a Federal Reserve Chairman or Secretary of Treasury. Mortgage debt in the United States has grown to be one of the most important factors that we need to manage for a growing economy.
Keep this new entity simple and operate it like Ginnie Mae operates. In fact, merge Ginnie Mae into this new agency. Ginnie Mae doesn’t purchase its own product, but instead, sells it all to investors. Compare annual reports. You’ll find it 50 times easier to understand the business model behind that of Ginnie Mae compared to the business models of the GSEs.
End the government’s involvement in subprime and outright purchase subsidies. These activities just put houses in the hands of people who ultimately cannot afford them. Instead, the government should encourage and reward financial responsibility. And here’s how to do that.
Have the new agency establish a 30-year 4.0% fixed rate mortgage program for highly qualified purchasers and refinancers with a minimum of 10-15% equity and good credit for “primary” residences under $500,000. This approach offers two major advantages: (1) it will reduce our long term debt obligations; and (2) it is a way to stimulate the economy better than we have been able to in the last eighteen months through increased government spending.
Back these loans and securitize them with the Full Faith and Credit Guaranty of the United States Government. Think of these new securities like long term U.S. Treasury Notes. Marginal borrowers that don’t meet new strict underwriting standards used by the new agency must go to the private sector banks for their mortgages which “will not” carry the same Government Guaranty.
One thing we should learn from this latest financial crisis. Not everything has been all bad. During this latest recession, heroes have stepped forward, and I would like to tip my hat to two of the most important: (1) the FDIC, which despite the TARP bailouts, has continued doing its essential job like it has in the past—shutting down the riskiest and most dysfunctional banks in America; and (2) maybe the most important of all, those American homeowners who month after month continued making their monthly principal and interest payments despite their deteriorating financial circumstances during the crisis. It is because of heroes like these that we are continuing to recover from the Greatest Recession since the Great Depression.
Jim Boswell (MBA, MPA, BA) directed the analytical risk monitoring activities of Ginnie Mae’s $500 billion portfolio of mortgage-backed securities for twelve years (1988-2000), including the period of the S&L crisis. His recent book, Crush Depth Alert, published by Fourth Lloyd Productions, explains in detail with supporting exhibits, graphs, and tables the factors that led up to the financial crisis while offering solutions on how to move forward.
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