The arrival of a new century is a perfect time for elected officials
to discard programs that belong in the old one. A task force in
Michigan, for example, has recommended repeal of the state’s
10-cent bounty on rat heads.
Although Congress passed the Gramm-Leach-Bliley Act last year to
remove some antiquated banking restrictions, it left in place a
nest of subsidized creatures that gnaw on taxpayers and financial
service providers alike -- the Federal National Mortgage Association
(Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie
Mac).
As established by Congress, Fannie Mae’s and Freddie Mac’s
intended mission was to help lenders make low-income mortgages more
available. Today, both entities are quasi-private firms with their
own shareholders and boards of directors; yet, they continue to
receive substantial subsidies and benefits from their relationship
with the federal government.
While most observers agree that Fannie and Freddie have been successful
in establishing a secondary market for mortgages and mortgage-backed
securities, there is also a consensus that the companies have enriched
themselves and their shareholders at taxpayers’ expense. As
Ron Feldman noted in the Federal Reserve Bank of Minneapolis’s
September 1996 edition of The Region:
In fact the federal government does not set the size of
the subsidy it provides Fannie and Freddie each year; the magnitude
of the subsidy from the implied guarantee, for example, depends
on the difference between how much Fannie and Freddie would pay
to raise money if they did not have special status with investors
(that is, their true borrowing costs) and how much they actually
pay with the perceived credit support of the federal government.
The size of the subsidy also depends on Fannie and Freddie’s
outstanding obligations. The weaker the financial condition of Fannie
and Freddie, the higher their true borrowing costs and the greater
the subsidy provided by the implicit guarantee. The more obligations
the federal government guarantees, the greater the subsidy.1
Fannie and Freddie’s special relationship with the federal
government allows the companies to borrow at rates below other private
firms because the capital markets believe the federal government
will stand behind the companies’ obligations. Add in the ability
to borrow from the Treasury, an exemption from state and local income
taxes, plus lower capital requirements than most other financial
institutions, and the total taxpayer subsidy reaches nearly $6.5
billion, according to the Congressional Budget Office (CBO).2
Table 1 shows the estimated gross and retained subsidy for both
Fannie and Freddie.
"Fannie Mae…is efficiently and effectively delivering billions
of dollars
each year in benefits to the low-- and moderate--income
home buyers Congress intends to help, at absolutely
no cost to the taxpayer."--James Johnson, Chairman &
CEO, Fannie Mae, April 1996.
Table 1. Estimated Gross and Retained Funding Subsidies,
1995
(in billions of dollars)
|
|
|
Fannie Mae
|
Freddie Mac
|
Total
|
|
Gross Subsidy
|
|
|
|
|
Average debt outstanding
|
278.3
|
105.7
|
384.0
|
|
Subsidy (70 or 68 basis points)a
|
1.9
|
0.7
|
2.6
|
|
Average MBSs outstanding
|
494.7
|
450.5
|
945.2
|
|
Subsidy (40 basis points)
|
2.0
|
1.8
|
3.8
|
|
Subsidy Pass-Through
|
|
|
|
|
Mortgages financed
|
719.1
|
529.9
|
1,249.0
|
|
Pass-through (35 basis points)
|
2.5
|
1.9
|
4.4
|
|
Funding Subsidy Retained (total subsidy minus pass-through)
|
1.4
|
0.7
|
2.1
|
|
Net Income Before Taxes and Gifts
|
3.4
|
1.6
|
4.9
|
|
Retained Subsidy (Percentage of net income before taxes
and gift)
|
41.1
|
44.9
|
42.3
|
|
Source: Congressional Budget Office.
Note: A basis point is one-hundredth of a percentage point.
MBSs= mortgage-backed securities
a. The savings for 1995 were 70 basis points for Fannie
Mae and 68 basis points for Freddie Mac
|
Despite their mission to assist low-income homebuyers, Fannie and
Freddie only pass $1 out of every $2 in these subsidies to homeowners;
the rest goes directly to the corporate bottom line. As CBO observed,
"scant evidence exists of public benefits from [Fannie Mae and
Freddie Mac] that would justify a retained taxpayer subsidy
that is more than $2 billion annually."3
"…Freddie Mac benefits buyers and renters at
no cost to the government."--Leland Brendsel,
Chairman, Freddie Mac, March 1996
Originally they were the only game in town, but now Fannie and
Freddie can use their taxpayer subsidies to undercut private lenders.
One economic expert likened the policy to the kind of "crony capitalism"
often found in the corrupt economies of Southeast Asia and Russia.
"As a result, Fannie’s bottom line has been nothing short of
sensational. Last year, the company earned $3.4 billion, up 14 percent
from 1997, and it is continuing that pace this year: In the first
quarter, earnings rose 14 percent to $925 billion."4
Today, Fannie and Freddie dominate the retail mortgage market by
owning or guaranteeing 40 percent of all mortgages. Together they
have approximately 65 percent of the market for mortgage intermediary
services and almost 100 percent of the market for securitizing conventional
mortgages. Fannie has the second largest market valuation among
financial institutions; its $70 billion market value puts it ahead
of Chase Manhattan and just behind Wells Fargo.
But the secret of this success --subsidies-- could also prove to
be Fannie and Freddie’s undoing. Given their market dominance,
Fannie and Freddie may need to pursue increasingly risky loans to
maintain a portfolio that has grown at 18 percent per year over
the past decade. An economic downturn or a change in interest rates
could cause substantial numbers of higher-risk borrowers to default,
sending Fannie and Freddie’s stock prices tumbling, and leaving
taxpayers holding the bag. If Fannie and Freddie do not expand their
pool of borrowers, they are likely to experience "mission creep"
as they compete against private financial institutions for other
services, such as home equity loans. As Jeffrey Zeltzer, Executive
Director of the National Home Equity Association has stated, "The
home equity area is a refinancing of consumer debt, or a home improvement,
or sending someone to college, or a family medical emergency. So
they’re not even within the mission."
At one point in time, it may have made sense to pay people in Michigan
to hunt rats. Before the development of national capital markets,
it may have made sense for the federal government to use Fannie
and Freddie to help homeowners obtain their first mortgage. Today,
folks in Michigan can earn money by turning in bottles and cans
instead of scalping rats. With the sophistication and efficiency
of capital markets today, taxpayers should not be subsidizing quasi-government
corporations that enrich shareholders and directors at the expense
of community lenders and low-income homebuyers. As governments get
set to clean house, Congress should do the same and let Fannie Mae
and Freddie Mac compete openly and fairly in the marketplace.
Dircksen is a policy
analyst for National Taxpayers Union.
Notes
1 Ron Feldman, "Uncertainty in Federal Intervention: Fannie Mae,
Freddie Mac and the Housing Subsidy Trail," The Region, Federal
Reserve Bank of Minneapolis, September 1996. http://www.mpls.frb.org.
2 Congressional Budget Office, Assessing the Public Costs and Benefits
of Fannie Mae and Freddie Mac, Washington, D.C.: The Congress of
the United States, xii.
3 Ibid. 32.
4 Owen Ullman, "Crony Capitalism: American Style," The International
Economy, July/August 1999, 7.
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