New York Fed Says Conservatorships Accomplished Three of Five Objectives

The Federal Housing Finance Agency (FHFA)’s conservatorships of Fannie Mae and Freddie Mac, which reached its seventh anniversary in September, accomplished three of five objectives, according to a commentary from the New York Fed titled “Evaluating the Rescue of Fannie Mae and Freddie Mac” on Thursday.

The quartet of Andreas Fuster, Joseph Tracy, and James Vickery of the New York Fed and W. Scott Frame of the Atlanta Fed said that an optimal intervention by the government into the operations of Fannie Mae and Freddie Mac would include five elements:

• The GSEs would be able to continue their core securitization function as going concerns, supporting the supply of mortgage credit
• The firms would continue to honor their current obligations as to debt and mortgage-backed securities
• Value of common and preferred equity in Fannie Mae and Freddie Mac would be extinguished, a reflection of their insolvent financial condition
• The firms would be managed with broader macroeconomic objectives in mind, rather than just maximizing the private value of the firms’ assets
• The rescue would be structured so that long-term reform would be prompted within a reasonable period of time

According to the authors of the commentary, the conservatorships accomplished the first three of those five goals.

“The financial lifeline provided by the U.S. Treasury enabled Fannie Mae and Freddie Mac to support mortgage supply through the crisis and its aftermath and to take up the slack left by the breakdown in nonagency securitization, thereby supporting the fragile housing market,” the authors wrote. “Holders of agency debt and mortgage-backed securities did not suffer credit losses, insulating the broader financial system from contagion effects. And both common and preferred equity holders were effectively wiped out, consistent with market discipline.”

As far as the objective of aligning activities of Fannie Mae and Freddie Mac with broader economic objectives, the authors contend that the conservatorships were less successful. The conservatorships were required by law to put Fannie Mae and Freddie Mac in a “sound and solvent condition” but this focus at times conflicted with other public policy objectives, such as the aggressive enforcement of the GSEs of “representations and warranties” whereby the firms “put back” large volumes of defaulted mortgages to their originators, according to the authors. As a consequence of the putbacks, underwriting standards were tightened and the cost of mortgage lending rose after the crisis, even though the putbacks were legally justified.

On the fifth objective of producing long-term mortgage reform, the authors of the commentary contend that the conservatorships have “strikingly failed.” The authors point out that Treasury Secretary Henry Paulson said, “We described conservatorship as essentially a ‘time out,’ or a temporary holding period, while the government decided how to restructure the [government-sponsored enterprises],” but the “time out” is now more than seven years long with no end in sight to the conservatorships.

Much legislation has been introduced to try and reform the GSEs and end the conservatorships. Nearly everyone agrees that a private system should replace Fannie Mae and Freddie Mac, but lawmakers cannot agree on how to implement such a system. As a result, the conservatorships continue indefinitely.

“The many legislative proposals to date all reflect the crosscurrents of trying to protect the taxpayer, preserve support for the 30-year fixed-rate mortgage, and keep homeownership affordable to a wide spectrum of borrowers,” the authors wrote. “While the lack of action to date is not cause for optimism, the current situation provides a unique opportunity to put the U.S. mortgage finance system on a more stable footing, an opportunity that we hope is not wasted.”