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What's Next: Life After Fannie And Freddie

Joe Raedle
Getty Images

This is part three in our series on Fannie Mae and Freddie Mac. Read part one, "Kill Them, Bury Them," and part two, "Self-Fulfilling Prophecy."

It's now clear that mortgage giants Fannie Mae and Freddie Mac were a bum deal for taxpayers.

For years, the companies reaped huge profits for their shareholders. Then, when they collapsed during the financial crisis, the government took them over and bailed them out — at a cost of $130 billion and counting.

"We need to wind down Fannie and Freddie and substantially reduce the government's footprint in the housing market," Treasury Secretary Timothy Geithner said recently.

A lot of other people in Washington, D.C., are saying the same thing.

"Goal one is to get the taxpayers off the hook. Goal two ... is to make sure that the taxpayers will never again find themselves in this situation," says Scott Garrett, a Republican Congressman from New Jersey.

So we've got the Obama administration, an influential Republican and, yes, an influential Democrat, too:

"I think they should be abolished," says Barney Frank, a Democratic congressman from Massachusetts. "The only question is, what do you put in their place?"

That question — What do you put in their place? — is where all the agreement falls apart.

But before we get to the debate over what comes next, here's a quick explanation of what Fannie and Freddie actually do.

When someone buys a house, they typically go to a bank to get a loan. Banks usually don't want to keep these loans on their books. So they sell them to either Fannie Mae or Freddie Mac.

Fannie and Freddie wrap bunches of loans into bundles called mortgage-backed securities. Investors — including pension funds, foreign governments, and banks — buy those securities.

Many of those investors wouldn't lend money to individual Americans to buy their homes. But they buy mortgage-backed securities partly because Fannie and Freddie promise that if a borrower stops paying, Fannie and Freddie will make up the difference.

For decades, the U.S. government implicitly stood behind Fannie and Freddie. (For more on the implicit guarantee, read part one in our series, "Kill Them, Bury Them.") Now, the guarantee is explicit.

The key questions for what to do next are: Should the government be involved in the mortgage business? If so, how big should its role be?

Dwight Jaffee, a professor at UC Berkeley who studies mortgage markets, says the government shouldn't play any role at all.

"If I were here telling you...we should get the government out of the beer business, you wouldn't be very surprised. In fact you would say, 'Why would we ever get the government in the beer market?' " says Jaffee.

"Mortgage markets lending ... it's the same story. Why would you ever want the government in it?"

Jaffee points to European countries that have higher home ownership rates than the U.S. despite the fact that their governments aren't involved in the mortgage market.

But many people disagree with Jaffee's vision.

"Let's make it very clear," says Lawrence Yun, chief economist at the National Association of Realtors. "Let's have a government role, right at the front."

Realtors, along with home builders, the mortgage bankers and others, are part of what some call "the Housing Industrial Complex."

This group benefited from the existence of Fannie and Freddie. Yun and the Realtors are now pushing to replace them with a new government agency that does a lot of the same things. And they're using the same arguments they used to use in support of Fannie and Freddie. Housing isn't like beer.

"It's just ingrained in the American mindset that to say, 'I own a property. I own piece of America,' " says Yun, explaining why housing is special. "I think that's all good for the country."

Yun and others warn that if the government pulls out of housing too far, loans will be harder to get and interest rates will go up.

Without a government guarantee, all those pension funds and foreign governments will be reluctant to lend Americans money to buy their houses.

"We are typically one of the largest holders in the world of agency mortgages," says Scott Simon, head of the mortgage division at the money management firm PIMCO.

His firm buys a ton of the mortgage-backed securities created by Fannie and Freddie. If the government backing goes away, he says a lot of investors like him wouldn't take the risk on mortgages.

"If it's not the banks, if it's not money managers and it's not overseas, who exactly is going to be this magic pool that takes a trillion dollars of mortgage origination every year and puts it on their balance sheets?" asks Simon. "And the answer is, we don't know."

So you've got people like UC Berkeley's Dwight Jaffee saying, you don't need the government at all. You've got Scott Simon and the Realtors saying, without the government none of this works.

And so, as sometimes happens in Washington, policy wonks everywhere are trying to find a middle ground: a little bit of government, but without all that pesky risk to the taxpayer.

One idea floating around makes the government's role explicit, but more limited. Private companies would shoulder most of the risk and take big losses in a crisis. The government would only come in as a last resort.

But Bethany McLean, co-author of All the Devils are Here, a book about the financial crisis, is skeptical that such a plan would hold up.

"You can put all the safeguards you want in place," she says "And everybody will say, 'Oh, we're going to do this so it's safe this time. ... Companies with the government guarantee aren't taking that much risk.' And it will start off that way."

But eventually, McLean says, we will forget what it was like before. The housing market will get better. The companies will start taking more risks.

"And we will be right back where we were before," she says. "The most likely solution is really a re-creation of Fannie and Freddie, except everybody will pretend that it's not."

Update, March 30th: Congressman Jeb Hensarling, a Texas Republican, recently introduced a bill that would end the government bailout of Fannie and Freddie. But it probably doesn't have enough votes to pass. So yesterday, Scott Garrett and others rolled out a separate set of bills that would keep the mortgage giants around, but on a shorter leash. Those bills would do things like raise the fees Fannie and Freddie charge to guarantee mortgages (also proposed by the Obama administration) and wind down the firms' investment portfolios.

This is part three in our series on Fannie Mae and Freddie Mac. Read part one, "Kill Them, Bury Them," and part two, "Self-Fulfilling Prophecy."

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Tamara Keith has been a White House correspondent for NPR since 2014 and co-hosts the NPR Politics Podcast, the top political news podcast in America. Keith has chronicled the Trump administration from day one, putting this unorthodox presidency in context for NPR listeners, from early morning tweets to executive orders and investigations. She covered the final two years of the Obama presidency, and during the 2016 presidential campaign she was assigned to cover Hillary Clinton. In 2018, Keith was elected to serve on the board of the White House Correspondents' Association.