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New York Fed Says Path for GSE Reform ‘Does Not Look Promising’

Federal Reserve Bank of New York GSE Reform [1]With GSE reform a hot topic among government officials and those in the housing industry, the Federal Reserve Bank of New York has issued a report [2] stating that the "path forward for reform of Fannie Mae and Freddie Mac does not look promising" and that failure to wind down the GSEs equated to a "colossal missed opportunity" to put U.S. residential housing finance on more stable footing.

The Federal Housing Finance Agency (FHFA [3]) took Fannie Mae [4] and Freddie Mac [5] under conservatorship in September 2008 at the height of the financial crisis. In 2008, the two GSEs needed a combined $188 billion bailout from the government to stay afloat; they returned to profitability in 2012. Despite now making billions per year in profits, the two GSEs remain in conservatorship.

The New York Fed reports that public actions supporting the GSEs succeeded in supporting the housing market and removing the GSEs as an "immediate source of systemic risk to the financial system. However, the conservatorships have not yet achieved the goal of reforming the system of residential mortgage finance." The report cited white paper on federal mortgage reform issued jointly by HUD and Treasury in February 2011, just two years into the Obama Administration, which then-Treasury Secretary Timothy Geithner described as a fundamental plan to wind down the GSEs; however, the New York Fed said the white paper was just a "plan to develop a plan" and offered no specifics as to how to achieve the reform despite offering three broad possible alternatives. The New York Fed, in its report, quotes former Treasury Secretary Henry Paulson as saying in his 2010 book that the conservatorships of the two GSEs was as essentially intended to be a “time out,” or a temporary holding period while the government determined how to restructure Fannie Mae and Freddie Mac.

"The key recommendation of the U.S. Treasury and U.S. Department of Housing and Urban Development (2011) white paper – that Fannie Mae and Freddie Mac should be wound down – would in fact not come to pass," the New York Fed wrote. "This would be a colossal missed opportunity to put U.S. residential mortgage finance on a more stable long-term footing."

Six and a half years after the government seized control of Fannie Mae and Freddie Mac, the New York Fed report states that there is no longer the same "urgency" to wind down the GSEs as there was in the years immediately following the crisis.

"The path forward for reform of Fannie Mae and Freddie Mac does not look promising," the New York Fed wrote. "As time passes since September 2008, the perceived urgency for reform seems to recede. Delay prolongs the uncertainty over the government’s future role in residential mortgage finance, which in turn is a deterrent to private capital re-entering the market, and makes the government’s role appear more difficult to replace. Delay also raises the likelihood that deeper reform will be judged as too difficult to accomplish, and raises the risk that the conservatorships are ended by returning Fannie Mae and Freddie Mac to private status with only minor changes to their charters."

Skepticism regarding GSE reform seems to be spreading. Earlier this week, Senate Banking Committee Chair Richard Shelby (R-Alabama) said in a speech [6] at the U.S. Chamber of Commerce that he did not expect GSE reform to take place for at least the next two years, which would be the end of the Obama Administration. Shelby previously opposed a bill that would eliminate the GSEs and replace them with a private insurance company system with a government backstop. The FHFA Office of Inspector General issued a white paper [7] in early March stating that the conservatorships would go on indefinitely.