What Problem Is Privatizing Fannie and Freddie Meant to Solve?

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President Obama’s chief economist, Jason Furman, weighed in behind efforts to privatize Fannie Mae and Freddie Mac last week. The main plan on the table is a bill put forward by Senators Tim Johnson and Mike Crapo, the chair and ranking member, respectively, on the Senate Finance Committee.

While Furman’s column (which was co-authored with James Stock, another member of the president’s Council of Economic Advisers) indicated support for the principles behind the Johnson-Crapo bill, it is not clear what problem they are hoping to solve.

At the moment, it seems Fannie Mae and Freddie Mac are doing their job just fine. They are issuing mortgage-backed securities (MBS) that include more than 60 percent of new mortgages. Interest rates on mortgages are low and both companies are making substantial profits which are refunded to the government. Why is there any need to overhaul this system?

The financial industry is of course unhappy with this situation. It sees the money being earned by Fannie Mae and Freddie Mac as money that could be going into its pockets. Of course there is nothing that prevents Goldman Sachs, Citigroup, and the rest from going out and issuing their own MBS right now.

The problem is that they have a really awful track record. Remember the financial crisis? And of course it is especially hard for them to compete with two relatively efficient government-run issuers like Fannie and Freddie.

Johnson-Crapo solves both problems for the industry. First, it shuts down Fannie Mae and Freddie Mac. This means Wall Street no longer has to worry about competing with them. But, Crapo-Johnson does more than just wipe out Wall Street’s competition; it also allows banks to issue MBS that carry a government guarantee.

Under Johnson-Crapo, investors would have 90 percent of the price of a privately issued MBS guaranteed by the government. This means that no matter how much garbage Goldman Sachs or J.P. Morgan threw into an MBS, investors wouldn’t have to worry about losing more than 10 percent of their investment. After an initial 10 percent loss, the taxpayers would be on the hook for the rest.

Proponents of Johnson-Crapo argue that the risk of losing 10 percent of their investment will ensure the quality of these MBS. Apparently these people are not old enough to remember back to the days of the housing bubble when investors gobbled up MBS issued by the Wall Street banks even though they could in principle lose 100 percent of their investment.

The moral hazard created by Johnson-Crapo, in which private banks get the profit and taxpayers get the risk, virtually guarantees the sort of abuses we saw during the housing bubble years. In fact, if we feel the need to get rid of Fannie Mae and Freddie Mac as government-run companies, it would make far more sense to just get the government out of the MBS market altogether.

The Wall Street boys will surely be able to figure out a way to provide credit for mortgages without the government holding their hands. They are able to do it now with the market for jumbo mortgages; if necessary we can send over some high school math majors to teach them to do it with the conventional mortgages handled by Fannie and Freddie.

It is worth challenging the idea that everything needs to be done by the private sector, even in cases where the government can do it more efficiently. This was the situation we faced back when President Bush wanted to privatize Social Security.

The privatizers derided Social Security as an old-fashioned one-size-fits-all model. The description is largely accurate, but that is exactly what we need in a system designed to provide workers with their core retirement income. According to the Bush administration’s own estimates, the administrative costs of their privatized system would have been ten times as large as the administrative costs of Social Security.

We can tell the same story with Medicare compared with private issuers. The administrative costs of the Medicare system are 2-3 percent of what it pays out for health care. By contrast, the administrative costs of private insurers are 15-20 percent of annual payouts. In addition, providers face higher costs because of the office staff they need to hire to deal with an array of different insurance forms. Nonetheless, because of the political power of the insurance industry, the only way to extend health insurance coverage through the Affordable Care Act was to cut them in for a big piece of the action.

In principle, the power of inertia should work in favor of keeping Fannie and Freddie in place. However many of those who were opposed to privatizing Social Security have taken the side of the financial industry in this battle. At the least, it should be possible to block Wall Street’s efforts to get a government guarantee for their new foray into the mortgage-backed securities market.

It is ironic that at a time when much of the liberal intelligentsia has become obsessed with Thomas Picketty’s new book warning about ever greater concentrations of wealth and income, this huge giveaway to Wall Street could pass largely unnoticed. Of course no one ever expected much by way of serious thought from intellectuals.