Stop Mortgage Investor Bailouts

An open letter to Occupy Wall Street


It really is frustrating when banks, institutional investors, and hedge funds make money off of taxpayer bailouts of the financial industry. That's a travesty well worth skipping a week's worth of showers for. Unfortunately, we cannot roll back time to reverse the TARP bailout.

We can, however, stop a bailout going on right now: taxpayer money flowing through Fannie Mae and Freddie Mac to mortgage investors to ensure they don't suffer losses from families defaulting on mortgage payments.

Three years ago, Treasury Secretary Hank Paulson coordinated a SWAT-like invasion of Fannie and Freddie's corporate offices, taking the government-sponsored enterprises (GSE) into federal control. Since then the Federal Housing Finance Agency has been pulling the GSE's strings behind the scenes, and the Treasury Department has used them to funnel $169 billion of taxpayer money to mortgage investors.

Since 40 percent of taxes are paid by the top 1 percent, Occupy Wall Street protestors can be satisfied knowing that at least some of the wealth of the elite has been wasted on this bailout—but since a lot of those getting this money are themselves most likely in at least the top 10 percent, that $169 billion bailout ends up flowing right back to them.

But try putting that on a sign.

These mortgage investors had paid fees to Fannie and Freddie to guarantee payment on the mortgage-backed securities they had invested in, but nowhere in their contracts were they promised that the government itself would step in to cover the guarantees if Fannie and Freddie ran out of money. Nevertheless, that is what the government has done—all under the guise of the need to protect the housing market. (If you're reading this on a generator-powered MacBook Air in Liberty Square, click here for more details on how this all works.)

Yet it turns out that keeping Fannie and Freddie perpetually in federal conservatorship is hurting the housing market.

The future housing market cannot depend on taxpayer guarantees of financial industry investment in mortgages. But right now Fannie Mae and Freddie Mac are keeping alternative housing finance systems from emerging by monopolizing the mortgage market. In fiscal year 2011, Fannie, Freddie, and the Federal Housing Administration bought or guaranteed 95 percent of new mortgages.

Yes, 95 percent. Every one of those mortgages is backed by taxpayer guarantees.

The reason is because Fannie and Freddie charge way below what private mortgage insurers would demand to insure mortgage investment. And that is basically the point, because if they charged the market rate there wouldn't be a need for Fannie and Freddie. The idea is that more people will invest in mortgages, making it easier to get a mortgage, if investors can get cheaper guarantees. The nature of the GSEs is to create subsidized risk at the expense of taxpayer funded bailouts.

Here is how out of whack the situation is: Fannie and Freddie currently charge around 0.25 percent of what investors make from buying mortgage-backed securities. The Congressional Budget Office suggests that the GSEs should really be charging 4.4 percent.

That may or may not be good material for a wonky sign, but it is a seriously distorted subsidy for the financial industry. It means that instead of collecting $12.5 billion for investor insurance on the GSE's $5 trillion in mortgage-backed securities, they should have $220 billion. That should inspire some rage among protestors.

The Federal Housing Finance Agency finally hinted last month that it will consider raising the g-fee, but likely no higher than doubling the current rate. Which would mean that the GSEs would still be significantly undercharging the financial industry for a guarantee that the taxpayers will cover their investments.

So what can we do about this? There are lots of proposals for how to dissolve Fannie Mae and Freddie Mac in a responsible way. The best method would be to raise the fee charged for guaranteeing mortgage investments steadily over five years to a level where no one wants to do business with Fannie and Freddie anymore, while at the same time forcing the GSEs to limit their business to smaller and smaller sized mortgages. After all, why should someone buying a $500,000 home need federal financing?

But even if you believe the government should help poor people become homeowners, Fannie Mae and Freddie Mac are a terrible way to do it. Public risk for private profit is not good public policy—which I think is the text on a protestor sign somewhere in lower Manhattan. It is one of the roots of the subprime crisis and subequent financial collapse. At most, subsidies for low-income families should be part of the budget and made transparent for debate—they shouldn't distort financial behavior and bail out risky investment failures.

So why haven't we done anything about this yet? Again, Fannie and Freddie were taken over three years ago. Both the Bush and Obama administrations have had an opportunity to address the failure of the GSE model. The Treasury Department even issued a White Paper in February this year arguing we do not need Fannie and Freddie to support the American housing industry.

Yet nothing has happened.

The Democrat-led Congress from 2009-2010 talked a lot about the financial crisis and spent a year debating reforms for Wall Street, but in the end passed the Dodd-Frank Act, which left in place the bailout for mortgage investors and tens of billions flowing from taxpayers to the financial industry. The Republicans have now had almost a year to address the GSE failure through their control of the House of Representatives, but aside from a handful of bills passed out of a House subcommittee this year, Congress has chosen to let Fannie and Freddie continue to subsidize mortgage investment risk with taxpayer funded guarantees.

This failure of leadership should inspire an Occupy Washington movement demanding that Fannie and Freddie be dissolved and taxpayer funded bailouts and guarantees for mortgage investors be stopped. We will not have a housing recovery until the GSEs are out of the way.

The Tea Party movement started with CNBC's Rick Santelli's rant about taxpayer funded mortgage modifications for delinquent borrowers. Occupy Wall Street can turn its fury on the same issue and possibly inspire our elected leaders to finally have the courage to end the policies that are keeping the American housing market down.

Anthony Randazzo is director of economic research at the Reason Foundation.