Treasury’s Claims About Fannie and Freddie Need A Reality Check

Fannie Mae and Freddie Mac are irredeemable failures, which must be abolished as the first step in any type of housing finance reform — if current and former officials of the U.S. Department of the Treasury are to be believed.

Going back to Timothy Geithner's tenure as Secretary of the Treasury, and continuing to present day, Michael Stegman and his peers are long overdue for a reality check. A few basic rules of mortgage lending, accrual accounting and capitalism go a long way toward debunking Treasury’s assertions.

Every financial services executive knows that loan loss provisions are subject to change. They draw keen distinctions between accounting provisions and cash losses, between solvency and liquidity. They never forget that a mortgage lender’s business model is all about getting the principal back plus interest and fees.

President Obama's Treasury Department chooses to ignore those criteria. Its policy agenda, to dismiss any talk of fixing the GSEs, is predicated on a refusal to acknowledge some inconvenient truths about the reversals of loan loss provisions and other non-cash write-downs. Beginning in 2012, when home prices began to recover, it became apparent that the catastrophic noncash losses reported by Fannie and Freddie were, to a large extent, ephemeral if not illusory.

Stegman, Counselor to the Secretary for Housing Policy, shuts down the conversation: “The critical flaws in the legacy system that allowed private shareholders and senior employees of the GSEs to reap substantial profits while leaving taxpayers to shoulder enormous losses cannot be fixed by a regulator or conservator because they are intrinsic to the GSEs’ congressional charters,” he said on Dec. 4, 2014, on March 5, 2015 and on Oct. 19, 2015.

As for taxpayers recovering their money, no company has ever come close to matching the GSEs' standards of excellence in mortgage underwriting. Fannie's track record — from 1971 through 2007 average annual credit losses were four basis points — is, by any standard, spectacular.

If subjected to measurement by Politifact's six-point Truth-O-Meter scale, the simple declarative statement, that long-term GSE loan performance is not exponentially superior to the rest of the market, would merit a False designation (only slightly better than a complete lie, tagged Pants on Fire).

Stegman’s verbose talking point would not fare so well under Truth-O-Meter scrutiny. Why? Because money talks. It says that taxpayers received $54 billion more than they paid out to support Fannie and Freddie during the housing crash. As noted earlier, the $187 billion “bailout” was not used to support the GSEs’ liquidity or ongoing operations.

But Antonio Weiss, also a Counselor to the Treasury Secretary, doesn’t seem to care. The cash proceeds returned to Treasury, “aren't adequate compensation for the extraordinary risk taxpayers took on and continue to bear.” Of course, the most salient risk borne by the GSEs and taxpayers is the result of Treasury’s decision to drain the GSEs of all capital.

Weiss takes two risks borne by taxpayers and conflates them into one. In so doing, he wipes away the legal distinction between the GSEs’ corporate charters and the U.S. Treasury. And he wipes away the GSEs’ essential role in liquefying the mortgage markets and saving the U.S. economy.

From 2007 onward, just about every private player, save Fannie and Freddie, stopped financing new mortgages for a very simple reason: Nobody wants to catch a falling knife. Home prices were falling, and history showed that every housing boom had been followed by a multi-year housing slump, which frequently turned into a bust. Since the GSEs had such a dominant share of the mortgage market, they, and only they, had the business incentive to increase their credit exposure as a way of stabilizing the market and arresting the free fall in home prices. As we saw in the wake of the savings and loan crises of the early 1980s and 1990s, and the housing crash of the 2000s, the GSEs stepped in to fill the void left by private market failures.

So, when tallying up the benefits that accrued to taxpayers by way of the GSEs, $241 billion in cash payments is only a small part of the equation. The much bigger benefit, affecting trillions of dollars of GDP and debt markets outside the direct purview of the GSEs, exists outside of Treasury’s cone of silence.

Finally, every public business decision is based on some kind of breakeven analysis, which tells us that 4%-5% capital levels would have kept the GSEs solvent during the last crash. Treasury ignores that number. And it ignores anyone who mentions that number, or other data points that conflict with its long-standing agenda.

David Fiderer has previously worked in energy banking for more than 20 years. He has written extensively about the financial crisis and is currently working on several projects concerning housing finance.