Exiting GSE Conservatorship Should Include Alternatives To Mortgages

There is an article in Politico that is compelling for its headline and subhead: Trump has a plan to remake the housing-finance system. It’s baffling to many lawmakers and experts. And the subhead further explains that, “The question of what to do with Fannie and Freddie, the two dominant mortgage financiers, has bedeviled policymakers for decades.” When I read this and all I could think is, “Well, yeah.” There just aren’t that many people that understand how the Government Sponsored Enterprises, Federal National Mortgage Association, Fannie, and the Federal Home Loan Mortgage Corporation, Freddie work in the first place nor the conservatorship that began in 2008. Mix in Donald Trump and the best word is “baffled.” Is there a simple explanation and idea about where to go next with mortgage finance?

For my own benefit, I ran through the simplest explanation I could give myself and share with others. The two entities, Fannie and Freddie are Government Sponsored Entities (GSEs) because they were created by the federal government. They are private, but because they are creatures of a federal directive, they function like a quasi-governmental entity. The purpose behind creating them, and GSEs is to increase the availability of credit, especially among consumers. Another example of a GSE is Sallie Mae, and entity created to increase access to loans for college education.

How do GSEs increase consumer borrowing for housing? They aren’t banks. That is, they don’t directly loan money, but they back loans, meaning that if a loan goes bad, the GSEs will cover the bad debt. But more typically, they buy the mortgages in order to keep liquidity in the mortgage market. When a borrower gets a loan from a bank, the bank sells that loan to one of the GSE’s which means it gets that money back and then can make another loan with it. This keeps cash flowing for people to close on homes, and for banks for keep making loans.

Once all those loans, debt, is taken on by the GSEs, they get capitalized by creating financial instruments, bonds, that use all that debt as collateral. Lenders on the market like these bonds, mortgage-backed securities (MBS) first, because millions of people are making monthly payments which means there is a ready revenue source to cover payments, but more importantly, if people stop paying those mortgages, the federal government will be sure they get paid back. Mortgage debt is the single biggest source of debt in the world behind United States Treasury bonds issued to essentially operate the United States government.

The amount of money involved is staggering. According to the Federal Reserve Bank of New York, total mortgage debt at the end of the first quarter of this year stood at $12.80 trillion at the end of March. As Donald Trump would say, “think of it,” the entire global economy was $105 trillion in 2023 and the United States economy is $26 trillion dollars. Mortgage debt is more than 10% of the entire world’s economy; it would appear as if the mission of the GSEs, to keep liquidity in the market has been achieved. But this means the American taxpayer is bearing an unbelievable amount of risk. And it is easy to see when people stopped paying mortgages in 2008, there was a serious problem for the entire global economy.

This is why the GSEs were put into conservatorship, a relationship in which the government essentially seized control of the operations of the banks. This was accomplished by legislative and administrative fiat (see the Housing and Economic Recovery Act of 2008) and through something called the Senior Preferred Stock Purchase Agreements (SPSPAs). Essentially, the federal government infused capital into the GSEs, first $100 billion then $200 billion, to keep them afloat by buying preferred stock in the companies. This was essentially a government buyout of the GSEs. Along with this came a tightening of the rules intended to avoid the profligacy of the previous decades. Human beings can behave very dangerously with money when they know they can’t lose when they place bets or make or take loans for housing.

Back to being baffled. Can this 17-year-old arrangement be wound down? Should it be? What would the consequences be? I can highly recommend a panel hosted by the Urban Institute with three former CEOs of the GSEs, David Brickman, Hugh Frater, and Donald Layton. Their conversation makes it pretty clear that the people who actually ran the GSEs don’t have complete consensus on what to do next.

Some ideas ranged from a slow exit over a decade to some form of privatization. But the idea discussed in the Politico article, selling stock in the companies, elicited skepticism. What is an investor buying if they could buy shares of the GSEs that are being operated by the government. And would this be enough to get the governments money, the hundreds of billions in preferred stock, out of the GSEs? And everyone worries what this might do to the markets and interest rates for consumers.

David Brickman used the word “cooperative,” something I floated in a post back in March. I suggested creating a National Cooperative Housing Finance Authority which could parallel the existing GSEs to lend for alternative forms of financing like buildings and loans, cooperatives, and rotating savings and credit associations (ROSCAs). He may not have meant it that way, but I prefer a solution that includes developing alternative structures of absorbing risk but for different forms of ownership like cooperatives. We could also shift funds from the Housing Trust Fund toward this end as well, providing the same kind of purchasing power for debt for cooperative housing that moved lenders toward making mortgage loans in the first place.