Earlier this week, the American Banker published a seductive op-ed arguing that Fannie and Freddie should be rolled up into a single GSE. This, it is said, would reduce taxpayer cost and shrink the enterprises into a more manageable form easier to put out of all our misery as soon as someone in power gets around to reckoning with the festering conservatorship. Seductive, as I said, but also dangerous as all get-out.
First, could Fannie and Freddie go into a combo GSE under current law? The op-ed is a bit unclear on this, but I think the answer is yes in effect, no in law. The reason for this is that current law doesn’t allow FHFA or anyone else to touch the separate GSE charters – no matter what is done to either GSE (including liquidation), the charters remain in law. This bars the usual M&A options for a troubled financial firm, but it doesn’t bar innovative restructuring. For example, FHFA could, if it desired, create a bridge GSE largely constructed out of Fannie Mae that is affiliated with a liquidating Freddie Mac. Complex, but something to contemplate if a single GSE were a good idea.
Which it isn’t. Even if the combo GSE were kept in conservatorship, it would be a mammoth, risky entity – all of its eggs in one mortgage basket under one model running off one system. Sure, there might be some cost savings in combining the two GSEs – one key argument in the American Banker op-ed – but the operational and concentration risks dwarf them and, indeed, doom the combo. That is, assuming a combo could even be constructed. FHFA’s strategic plan shows that Fannie’s and Freddie’s systems are so different that combining them now is a square-peg/round-hole undertaking with significant risks all its own.
In a bridge GSE – the construct contemplated by the American Banker piece – these concentration and operational risks become even more daunting. A bridge is not the ward-of-the-state conservatorship construct in which, at least theoretically, a GSE’s risks are contained by on-site government intervention and taxpayer control. A bridge is a new private company – hence its appeal to many who want to privatize Fannie and Freddie. Put all the eggs described above in a privately-held basket (assuming it’s even possible) and the concentration and operational risks turn into market-distorting ones.
To consider how much clout a privately-held GSE would have, even under continued federal regulation, turn back to Fannie and Freddie of yore. Sure, there were two of them, but even so they dictated almost every meaningful mortgage underwriting, servicing and securitization practice in the conventional, conforming space. They then took untold risks with their own minimal capital – kept as is in a bridge under current law – and with the stability of the U.S. housing-finance system and broader economy. Why did they do it? Because they could.
Would a new combo GSE in a bridge structure be too high-minded or so much better regulated that it wouldn’t sin as its forebears did? Or, would its mighty hand grab for all it could?