March 23rd 2010 our Treasury Secretary Tim Geithner promised to fix mortgages while testifying to the senate banking committee. To better understand the latest news from Washington I thought a little history was necessary.
During the Great Depression, as borrowers defaulted on mortgages banks found themselves strapped for cash, President Franklin D. Roosevelt and Congress created Fannie Mae in 1938 in order to buy mortgages from lenders, freeing up capital that could go to other borrowers. Although Fannie Mae began with just $1 billion in purchasing power, the agency helped usher in a new generation of American home ownership, paving the way for banks to loan money. Fannie Mae grew so large over the years that in 1968, with the pressures of the Vietnam War straining the national budget, President Lyndon Johnson took Fannie Mae’s debt portfolio off the government balance sheet; Fannie Mae was converted into a publicly traded company owned by investors. Two years later, Freddie Mac was launched, primarily to keep Fannie Mae from functioning as a monopoly. It went public in 1989. Today, the two companies dominate the mortgage market. In 2008 Fannie and Freddie were holding $5 trillion in debt. They were holding nearly 1 in every 5 loans made.
Fannie and Freddie raise cash to buy mortgages from a variety of sources, including pension funds, mutual funds and foreign governments. Their influence on economies at home and abroad is pervasive enough that the Federal Reserve and the U.S. Treasury felt they had little choice but to offer assurances that the companies will not be permitted to collapse. In some ways, the Federal Reserve’s current promise to loan the companies money, along with the Treasury Dept.’s proposal to invest in them if it becomes necessary, echo the days when the government first stepped into the mortgage market. Just as it was in 1938, the idea is to use tax dollars to prevent a complete meltdown in the U.S. financial sector that could trigger a global panic. We’re not in a Great Depression, but the intervention is an indication of how concerned the government is about more turmoil to come.
So why are they in trouble?
As home prices fell, so did the value of the mortgages the companies held, lowering their already small cushions of capital. As more of the loans they had backed went bad, they were no longer able to raise money from private sources.
So why should we care?
If the government hadn’t stepped in, and Fannie Mae and Freddie Mac had failed, the damage to the mortgage and housing markets would have been huge. The overall financial system and the nation’s economy also could have been hurt badly. In addition, the federal government is now explicitly guaranteeing debt issued by Fannie and Freddie. If defaults on mortgages held by Fannie and Freddie are greater than currently expected, the amount paid by taxpayers could be substantial.
So back to yesterdays testimony. According to Mr. Geithner the long awaited overhaul of Fannie and Freddie could start to take shape this year. Geithner acknowledged that devising a new system to finance U.S. house purchases would be a “complicated, consequential” process. He emphasized that he hasn’t “seen an ideal model” to replace the current arrangement, which is widely viewed as undesirable because of its role in inflating the housing bubble and the conflict between Fannie and Freddie’s profit-seeking and public policy missions.
But with the Senate moving ahead on reform of bank regulation, “we’re at a point to begin” the process of shaping housing-finance legislation, Geithner said. “I don’t see why it should take years.” Geithner said Tuesday the government will eventually recognize “substantial losses” from running the companies.
0:00 /4:22Geithner’s bailout burden
At the same time, Geithner said it would take time to create a plan that keeps mortgage credit widely available, protects consumers and ensures the financial system remains stable.
Fannie and Freddie have emerged as central to the administration’s support for the nation’s troubled housing markets. The Treasury’s funding for the companies and the Federal Reserve’s purchases of their debt have kept U.S. mortgage rates at historically low levels, making houses more affordable and offering some support to tattered bank balance sheets. Geithner said he believes there is “a quite strong economic and public policy case” for federal mortgage guarantees of some sort. He cited the need for “a stable housing finance market.”
Geithner said the administration will solicit comments starting next month from “a wide variety of constituents, market participants, academic experts, and consumer and community organizations.”