Sen. Corker’s decision this week not to seek re-election not only speaks volumes about life in the U.S. Senate these days, but also about the future of GSE reform, where the Tennessee Republican has long played a critical leadership role.  Earlier this week, I said that we shouldn’t let the politics of GSE reform dictate our thinking — need to keep our eye on the real story: two companies on government life-support with a combined $5.4 trillion in obligations will have zero capital between them in 2018.  That’s the financial-policy equivalent of letting two 18-wheelers careen down a Rocky Mountain switchback without brakes.  This doesn’t usually end well.

Since the GSEs were put into conservatorship in 2008, U.S. regulators have created a false sense of complacency, largely because recognizing the GSEs for what they still are scares them stiff.  How could anyone not think GSE debt and MBS are damn-close to Treasuries when the Federal Reserve holds $1.8 trillion of its balance sheet in agency obligations, not distinguishing between Ginnie Mae’s full-faith-and-credit obligations and those of the GSEs.  The GSEs’ own regulator describes their federal guarantee as “effective,” and who could doubt it given the Fed’s faith in a Treasury backstop.  U.S. liquidity rules similarly do not differentiate between agency obligations, making it seem that the only difference between a direct Treasury obligation and GSE paper is pre-payment speed pricing risk, far afield from fundamental risk of default – where that “effective” guarantee comes in – unless it doesn’t. 

Would the Trump Administration try to block a Treasury draw under exigent circumstances?  I doubt it, but then I wouldn’t have thought an Administration could talk so casually about a government shut-down or debt-ceiling lapse as this one did until it didn’t.  What the Trump Administration would do in the event of a draw is anyone’s guess despite Treasury’s contractual obligation because this Administration does what it wants when it wants to. 

Another reason to worry about continuing the conservatorships in the absence of a capital cushion is seen in just how many major mortgage-finance entities are more than okay with the status quo.  Members on both sides of the aisle have made it clear that new-style GSEs would have an explicit guarantee that would be paid for with up-front, deep risk buffers comprised of private capital.  Whose capital, how much it costs, and where this cost cuts into mortgage spreads remains to be determined, but one thing is clear:  the going will never be this good again.

The willingness of many private-sector entities to live with GSEs in permanent conservatorship may be attributable to self-interest, but the deep dependence of the entire housing-finance sector on the GSEs creates systemic risk of its own.  Even if investors are secure in the backstop provided by an “effective” federal guarantee, what would happen to residential-housing finance if Fannie and Freddie curtailed their securitization operations under stress?  With at least eighty percent of mortgage finance depending on them and the U.S. macroeconomy still deeply dependent on housing growth, the short answer to what would happen if the GSEs were stressed is nothing good.

Would all this risk be washed away if Federal Housing Finance Agency Director Watt used the unilateral discretion he says he has to withhold payments to Treasury and build a GSE capital cushion?  Many groups are calling for this not because they are as worried as they should be, but rather because a capital cushion reduces the chances of short-term disruptions and thus keeps the conservatorship’s good thing going. 

Even more problematic with a new capital cushion is the question of who owns it.  Money denied to Treasury is money owned by GSE shareholders who to this day are private investors.  Allowing shareholders – many of whom bought their investments in hopes of stepping in ahead of taxpayers – to profit from the systemic risk the GSEs present is a repeat of the heads-I-win, tails-you-lose business model that brought us the costly conservatorships in the first place.  Remember that even with a bit of a capital cushion, Fannie and Freddie are huge – a real capital cushion, say five percent against all MBS and the GSEs’ portfolio would be $336 billion.  Don’t wait up.

So, Sen. Corker, please do what you can to make GSE reform a legacy issue in which you use your formidable persuasive powers to bring competing interests together to design a new looking housing finance system that uses taxpayer subsidies for borrowers who need them the most, not industries that demand them the loudest.