A Proposed Reboot for Fannie and Freddie

By Brian Summerfield, Online Editor, REALTOR® Magazine

A proposal to take Freddie Mac and Fannie Mae’s bad assets off the books and restructure the two organizations is scheduled for discussion at the White House’s National Economic Council today. A central part of the plan is the creation of a permanent, government-supported “bad bank” that would always be there to back up Fannie and Freddie by absorbing any toxic debts. (This idea originated with James Lockhart III, the chief regulator of the two companies and head of the Federal Housing Finance Agency, who recently announced that he’ll be stepping down from that role at the end of this month.)

Proponents of the move say this would shore up the organizations and get them funding mortgage loans again, which they haven’t been doing much of since their near-collapse in the summer of 2008. (The Federal Housing Authority has stepped up to fill some of the vacuum left by this breakdown in the mortgage lending system.) By reducing both bad assets and risk, Fannie and Freddie would be in a position to resume their roles as the prime movers of the mortgage market, which would in turn boost the housing sector and, ostensibly, the entire economy.

However, there are potential problems with the plan. For one thing, it’s going to mean a large and enduring government presence in mortgage lending. While Fannie and Freddie were created by the feds, they were both run as private institutions with a considerable level of autonomy prior to last year, when the market bust led to a government takeover.

With this new set up, “ownership” of Fannie and Freddie likely wouldn’t change, and government involvement in the operations of these organizations probably would increase. Free-market advocates would argue that transferring control of the mortgage lending system from the private sector to government hands is a perilous proposition, and would invite inefficiency and mismanagement. (Of course, backers of this approach could argue that Fannie and Freddie were mismanaged during the height of the housing boom, when they were privately operated.)

Also, there could be problems that stem from moral hazard. Essentially, borrowers might be more inclined to take on mortgages they can’t really afford and default on those loans — and lenders might be willing to take more chances on unfit borrowers — in a “bad bank” system that everyone knows is ultimately propped up by tax revenues.

Whether you’re in favor of this proposal or not, there’s really no disputing that major changes to Fannie and Freddie are necessary. In fact, we’ve written about the need for an overhaul before.

Our question for you: Do you think wiping Fannie and Freddie’s slate clean and giving them a dumping ground for their toxic loans is a good move? Or should there be some other combination of regulation and restructuring? Or should the organizations have to climb out of the hole they’re in on their own, and accept a reduced role in mortgage lending for the foreseeable future?

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