Lets Trade the GSEs for an Increase in the Debt Ceiling

The idea behind the debt ceiling was to be a signal for Congress that it was spending too much. That doesn’t seemed to have worked. Instead Washington spends—whether run by the Dems or GOP—and just deals with how to raise the ceiling when it gets there. It’s as if we are headed towards a cliff and whenever we get to the warning sign telling us to turn the car around we have the park rangers move it further down the road.

Ideally, instead of raising the debt ceiling next month, Treasury would simply prioritize debt payments and then—instead of being able to borrow more money—use federal revenues for outlays while curbing payments on discretionary spending. That’s probably politically impossible.

So what is an alternative? We need to get America’s debt under control, and this will most effectively be done with the budget for FY2012… which is another big debate all together. So one option, if Congress is going to raise the debt ceiling anyway, would be to tie it to a legislative requirement that the FY2012 budget meet a certain reduction in short-term deficits and long-term debt.

Even that may be difficult to get all sides to agree on. After all, Obama and Ryan are about $2 trillion away from each other right now.

A second option—and a good option—would be to trade a temporary increase in the debt ceiling to cover FY2011 spending for an execution sentence for Fannie Mae and Freddie Mac.

Currently, the CBO considers the GSEs to be government agencies given how closely they are run and managed by FHFA and Treasury. We’ve already bailed them out with more thant $150 billion in taxpayer funds and Treasury has extended to them an unlimited line of credit. Fannie and Freddie have a combined portfolio of about $1.4 trillion in loans and total liabilities of $6.5 trillion. This means the threat of not shutting down Fannie and Freddie (and a potential partisan failure of Congress to address housing finance reform) and leaving them as wards of the state is a threat to America’s long-term debt.

It would be a huge win for fiscal responsibility if we could sunset the charters of Fannie and Freddie, preferably in no longer than five years. The House Financial Services committee is juggling to possible paths to winding down the GSEs, but each is still uncertain to meet with full House approval much less Senate approval, particularly before the Presidential campaign heats up next years.

So how would this work?

First, the debt ceiling debate should just be about FY2011. Spending beyond that, whether it needs a higher temporary debt ceiling or not, should be a part of the FY2012 budget debate. So we would only be talking about upping the ceiling for borrowing over the next six months.

In exchange, Congress would mandate that within five years—perhaps September 30, 2016, at the end of that fiscal year—Fannie Mae and Freddie Mac’s charters would expire, causing them to shut their doors and cease operations.

The mortgage industry would surely freak out at this. And after all the GSEs (plus FHA) are backing about 90 percent of all new mortgages originated. But a five year window would be plenty of time to transition Fannie and Freddie out of the housing market, while also winding down their portfolios.

I have suggested ways to do this in Congressional testimony and various papers published by Reason. Easy ways to do it would include increasing the fee Fannie and Freddie charge to guarantee mortgages until they are priced out of the market, and/or lowering the maximum sized loan they are allowed to purchase or guarantee. Furthermore, the Treasury Department has also outlined a similar plan that suggests winding Fannie and Freddie down over a five to seven year time frame.

Congress could either act to put this transition plan in place by law, or the regulators could do it themselves. FHFA has the authority to raise g-fees and lower the conforming loan limits. They could force the GSEs to speed up the wind down of their portfolios. And they could manage the process while monitoring its impact on the housing market to try and lessen any shock to the system.

Over that five year window, the private sector would slowly step into the space vacated by Fannie and Freddie—since the taxpayer subsidized GSEs would no longer have a price advantage monopolizing the marketplace. There are trillions of dollars investors available for assets that generate decent yield (i.e. not government backed assets like agency debt, Treasuries, or munis) that could be put into fully private mortgage-securities. The liquidity is there, the private sector could replace the GSEs and it could happen in an orderly process.

This would spark a recovery in the housing market—which still may take three to five more years—and eventually economic growth broadly speaking. This would a trade well worth it for fiscal responsibility and economic stability.