“If you think about homeownership as the major way the middle class—at least since World War II—has built assets, it also is part of our concern about inequality, economic growth, and social harmony.”
—Ellen Seidman, Director of the Office of Thrift Supervision, 1997–2001
In early 2014, just after investors had begun to sue, the White House was finally able to replace Ed DeMarco as the acting head of Fannie and Freddie’s conservator. This happened after Democrats, frustrated by their inability to confirm nominees, took the dramatic step of eliminating filibusters for most of the president’s nominations. This allowed the administration to appoint Mel Watt, a gracious, charming, liberal Democratic former congressman from North Carolina and a longtime evangelist for homeownership.
DeMarco took a position at the Milken Institute, a pro-market think tank run by former junk-bond king Michael Milken. (Right around that time, Milken wrote an op-ed for the Wall Street Journal in which he argued that subsidized mortgages create nothing good. “Investments in quality education and improved health will do more to accelerate economic growth than excessive housing incentives,” he wrote.) A few months later, DeMarco gave a speech at the Richmond Federal Reserve. “Restoring Fannie Mae and Freddie Mac is not the solution,” he said. “They failed and their business model failed. Going backwards to an obviously failed model cannot be dressed up with some promise of higher capital or explicit rather than implicit guarantees.”
Despite the fight between DeMarco and the administration over principal reduction, the appointment of Watt seemed like an odd lurch, given that based on everything that had been said publicly, DeMarco and the White House seemed to agree on a critical issue: the need to kill Fannie and Freddie. There were some in the administration, particularly on the economics team, who were opposed to Watt’s nomination for that reason. “It sent a signal that we were jerking this to the left,” says a former official. And although Watt, at least initially, would not be as liberal as some wanted, and he is still new in his role, it’s safe to say that some of what happened next would never have happened under Ed DeMarco. “He’s certainly not focused on shrinking their footprint,” Mark Calabria told the American Banker. “Almost everything he has done makes it more likely that the status quo continues.”
Watt walked into a tough situation, even beyond the political stew over the eventual fate of his wards. Almost seven years of government control over every aspect of their operations were and are taking a toll on Fannie and Freddie, even beyond the people problems you’d expect when employees don’t know if their company will exist in a few years. “It is running a low-grade fever all the time,” says one employee. Although the FHFA, Fannie and Freddie’s regulator, says that it has “delegated” to the CEOs and boards “responsibility for much of the day-to-day operations,” this person claims that the FHFA is doing what a government agency usually does, which is to try to impose systems that will eliminate the exercise of human judgment. This is a problem, because huge, fast-moving markets like the mortgage market require the constant exercise of human judgment. “If the country wants to have this function, you want it to be nimble, because that’s what financial markets require. We are not nimble,” this employee says.
“It [conservatorship] has been structured as purgatory,” says a former Fannie executive. “Conservatorship is a misnomer. You conserve in anticipation of something. There has been no something.” He adds: “The fact folks miss is that people who have neutered are negotiating billion-dollar transactions with these big banks.”
To those who have been on the inside, conservatorship may be sustainable, but it is far from ideal. “GSE Island” is how one former FHFA employee describes his view of life inside the agency, because he says the FHFA, in its policies and focus, is so different from other regulators. Under conservatorship, it has been impossible for either FHFA or the companies to make long-term decisions, like those about strategic investments, or personnel. He also claims that FHFA, which is intimately involved in the day-to-day activities of Fannie and Freddie, can at times be hindered by a lack of experience regulating financial institutions, combined with an odd mixture of inherited subservience and passive-aggressiveness toward Fannie and Freddie left over from the old days of OFHEO, its predecessor agency. He says he’d hear longtime FHFA employees say, “Well, they’re just too big to regulate.”
In addition to the existential issues, Watt also had to cope with short-term pressure to do something, anything, to help fix a still-struggling housing market. The overall homeownership rate is down to 64 percent—not incidentally, about the same level as in the early 1980s at the advent of securitization. The rate has fallen particularly steeply in minority communities. New home construction and new home-purchase mortgages are lagging badly. “While housing usually leads the country out of recession, this time it is an anchor,” Jonathan Weisman wrote in the New York Times.
The crisis and the slow recovery have not done much to affect the country’s stated commitment to homeownership. In some ways, the fragile economic times have only intensified it. “I think it’s important to understand this is not some abstract problem,” said Ellen Seidman, the former director of the Office of Thrift Supervision in the Clinton Administration, at a recent panel at the Urban Institute. “It relates to the question of how we will house an America in which many more families will reach their 30s and 40s burdened with student debt, with less certain and lower incomes, and less family financial support than was the case for the last two generations.”
Policy makers and politicians across the board, from Federal Reserve Chair Janet Yellen to President Obama, have started complaining about credit standards being too tight. This criticism would have been unimaginable only a few short years ago when memories of the crisis were visceral. The pendulum swung with astonishing speed, and Fannie and Freddie are at the heart of the complaints. Partly because they have no capital with which to absorb losses, since 2008 Fannie and Freddie have purchased mortgages made to people with almost pristine credit. According to the National Community Reinvestment Coalition, in 2012 Fannie and Freddie would only purchase mortgages made to people with credit scores of over 750, but barely one in five households in the country has a mark that high. This drastically limits the number of people who can get mortgages. Critics say, just as they did before the crisis, that Fannie and Freddie should be taking more risk so more people have the chance to become homeowners.
And without GSE backing, banks have shown very little interest in lending to American homeowners, even ones with very high credit scores, despite DeMarco’s having tried to entice private capital into the housing market by raising guarantee fees. Last year, there were fewer than $10 billion of private-label securities sold, compared to a peak of over $1 trillion before the crisis. “Everyone seems to think when it gets back to normal, the banks will come back in,” says a former Fannie lobbyist who now works for one of the big banks. “But we are seven years post-crisis. I don’t see an end in sight. I think we’re in this for quite some time.” “Everyone says that if we increase guarantee fees enough, private capital will come back in,” David Min says. “But there is no evidence that will happen. Literally, there is zero evidence.”