With Fannie and Freddie Profitable, Government Eyes Exit

The bailout and government ownership of Fannie Mae FNMAFNMA and Freddie Mac FMCCFMCC has been tumultuous at best. The controversial bankruptcy and bailout of the two government-backed insurers, politically motivated to maintain diplomatic ties with allies including China, may now finally be starting to see some light at the end of the tunnel.

Bailout Exits

The government has recently been exiting many of the bailouts executed in the beginning, height, and after-math of the financial crisis that started in 2007 with a slump in the housing market. Mortgage lenders, insurers, investment banks, automotive companies, and credit unions were just a few of the companies to require government assistance in the crisis.

Two notable bailouts that have seen no end to date are those of the government sponsored enterprises (GSE's) Fannie Mae and Freddie Mac. Efforts in the Senate may now be paving the way for a huge debate over the future of these organizations as well as a broad-based debate over the size of the government and the future of banking as a whole.

Bi-Partisan Bill

An effort led by Republican Senator Bob Corker of Tennessee and Democrat Mark Warner of Virginia is now starting to lay the framework of an eventual unwind from the bailout of the insurers and create a much smaller role for the government in the $10 trillion U.S. mortgage market. So far, approximately $370 billion has been injected into the two lenders and the GSE's have also had access to extremely low-interest financing from the Federal Reserve.

It is important to clarify that Fannie and Freddie don't make loans but instead buy them from lenders and securitize the loans into bonds, not unlike an investment bank. Their middleman role made more widely available the 30-year fixed-rate mortgage by matching banks and other lenders with investors, such as pension funds that are willing to manage the interest-rate risk associated with long-term, fixed-rate mortgages.

Solution

The Corker-Warner proposal seeks to dismantle the two GSE's and allow the private sector to purchase loans and securitize those loans with a government guarantee for "catastrophic losses on mortgages issued as bonds from a new guarantor, called the Federal Mortgage Insurance Corp." The FMIC would not actually securitize loans like Freddie and Fannie but would instead simply provide a backstop to the mortgage market, similar to the FDIC for deposits.

Other proposals seek to significantly downsize, but not eliminate, the current GSE's and use them in a slightly different manner. The end proposal will most likely come down to a debate over big vs. little government. Either way, any solution is a step towards government exit.