A Treasury GSE Management Failure

It is time for Treasury to fulfill it's management responsibility of GSE debt issuances

With taxpayers already shelling out $150 billion to bailout Fannie Mae and Freddie Mac and the government supporting 90 percent of the mortgage financing market, it’s time for the Treasury Department to step up to the plate and start taking better responsibility for the government-sponsored enterprises (GSEs).

One way to slow down the mortgage giants and begin to allow the private sector back into the mortgage finance world would be for Treasury Secretary Timothy Geithner to exercise his authority to approve (or disapprove) new debt issuances by Fannie Mae and Freddie Mac. While the Treasury and the Federal Housing Finance Agency have been watching over the GSEs, they have largely been used as pawns in an unorthodox scheme to try and support the housing market. With virtually every housing metric at its lowest point on record, this has clearly been a failed approach. The path back to a stable housing market, with sustainable growth, is not through the short-term support of the U.S. government. It is by letting the private sector back into the mortgage lending space by making the GSEs less competitive.

In Fannie Mae and Freddie Mac‘s charters, Congress granted the Treasury Department authority to review and approve any new debt issues by the GSEs. This means that when the GSEs want to borrow money to fund their activities, Treasury gets the final say as to whether they can move forward with their plans.

Former assistant secretary of the Treasury Emil W. Henry Jr. noted in a 2010 op-ed that Treasury exercised this duty for decades, with the GSEs submitting each new debt issuance to the department for prior approval. It wasn’t until the Clinton administration decided the review and approval process was overly bureaucratic-and a burden on Treasury employees-that the approval process was weakened. “This hands-off approach represented an abdication of Treasury’s essential oversight powers,” wrote Henry Jr. Combined with changes in 1992 to the missions of Fannie and Freddie, this was the beginning of the end for the GSEs, who without effective oversight spun steadily out of control.

In 2003, about a decade after the Clinton administration debt approval abdication, a series of bills were introduced in Congress to address reforming the regulatory structure for Fannie and Freddie. While many of the proposed bills tried to strengthen Federal oversight of the GSEs, Rep. Ron Paul (R-TX) sponsored a piece of legislation that sought to create a stronger divide between Uncle Sam and the mortgage giants. His bill, H.R. 3071, would have repealed the requirement that the Treasury approve Fannie and Freddie debt issuance, removed the GSEs exemption from state and local taxes, and relinquished the authority of the Treasury to purchase GSE obligations.

At the time, the GSEs were simply notifying Treasury that they were issuing debt and not even waiting for the rubber stamp of approval. The Paul bill, which didn’t even get a committee hearing, would have simply made formal what was already the case in practical terms-Treasury was not following through on its legal obligation to review GSE debt issuance.

Somehow, the accounting scandals at Fannie and Freddie in 2004 did little to change the practice of the GSEs. The mortgage giants eventually began sending just a single piece of paper to the Treasury, listing how much debt they were issuing, with no review process beyond acknowledgement of the news. Even with Sarbanes-Oxley requiring more transparent accounting practices in the private sector, the GSEs managed to fly under the radar.

While there might have been cause back in 2003 to try and separate the GSEs from the federal government, in order to make them purely private companies, that time has passed. Now that Fannie and Freddie are in conservatorship, they have essentially become government agencies (even the Congressional Budget Office includes the GSEs in its federal budget assessments). Much like how has-been celebrities Tila Tequila and Lindsay Lohan never seem to go away, Fannie and Freddie have been a thorn in the side of American taxpayers for far too long. It’s time to put them out of their misery. Ending our own misery in the process is a bonus.

Congress should seriously consider encouraging the Treasury to resume its legal duty to review GSE debt issuance and require proper documentation as to the need and benefit of any increases in borrowings. Secretary Geithner should commit appropriate resources to a rigorous review of debt issuance proposals and seriously consider rejecting some of their requests. Henry Jr. proposes that the Treasury should start denying requests, with the goal of reducing GSE debt by 50 percent by 2015 and 100 percent by 2018. During that time, the private sector would have the opportunity to step back into the secondary market and supplant Uncle Sam as the financier of American housing.

But even if Treasury does not choose to deny debt issuance requests, it would be important for Secretary Geithner to resume the duty of signing-off on each proposal. This would make Fannie and Freddie more transparent and force the Treasury to take responsible for any future failures at the GSEs.

Combining decreased debt issuance with other reforms-such as increasing the guarantee fee charged by the GSEs and FHA, lowering the conforming loan limits, freezing new activities, and increasing the pace of the wind down of GSE portfolios-Fannie and Freddie could be responsibly worked out of the housing market over the next five years. This would allow the private sector to become the sole provider of credit for mortgage lending and ensure investors have enough knowledge to accurately price risk and make decisions on the best places to invest their cash.