PolicyCast: Turn GSEs into Utilities? Why That May Be a Bad Idea

Kirk Willison, Arch MI’s Vice President for Government and Industry Relations:

When we last met with Edward Pinto of the American Enterprise Institute, he spoke about the history of government-created racial inequity in housing and how he proposes to help low-income and minority households build equity faster through an innovative loan product. In the second part of our conversation, we chatted about his views on reforming the two Government-Sponsored Enterprises, Fannie Mae and Freddie Mac. Along with AEI’s Pat Lawler and Alex Pollock of the R Street Institute, Pinto recently published a white paper titled “Another Bad Idea: Fannie and Freddie as Utilities.” The utility model for the GSEs is embraced by an array of housing interests on both the left and the right, including the National Association of Realtors®, the Center for Responsible Lending, the former Trump Administration’s Treasury Department and former Freddie Mac CEO Don Layton. I began by asking Ed why these groups favor the utility model.

Edward J. Pinto, American Enterprise Institute (AEI) Senior Fellow and Director of the AEI Housing Center:

Okay. So let’s start with everybody you mentioned is part of what I call the government mortgage complex. They benefit from having the government provide some type of expanded support, and that’s what the utility model is about. That’s number one. And we call that rent-seeking. Rent-seeking is where some company or group will make money because of policies that get put in place and it creates distortions in markets, and they’re able to get more profits than they otherwise would. So what do we see as the purpose of having Fannie and Freddie’s utilities? First and foremost, the housing government mortgage complex wants the 30-year guarantee by the federal government broadly applied to virtually all mortgages, maybe below a certain very high limit, but even broader than it is today potentially.

We’ve had massive problems with government guarantees. Government guarantees are highly inflationary. Look what’s just happened with student loans. Student loans are a perfect example, and that’s where Treasury literally took over the student loan business and it was supposed to reduce costs. Instead, we’re probably going to face a $1.3 trillion hole … We’re going to face probably a $500 billion or $600 billion hole in the student loan program when all is said and done in terms of not being repaid, Treasury not being repaid. So having a government guarantee generally leads to higher prices — higher prices at universities, higher tuition and higher prices of houses. As a general matter, I’m against that because I want prices to stay more in line with people’s incomes. Second of all, one of the big goals of having this utility is that it would take some extra money, just a little bit, and then it becomes more and more and more, and it would funnel it into some types of trust funds or, as I call it, a cookie jar for various affordable housing programs.

Affordable housing programs are programs that make housing affordable by subsidy. They provide subsidies, but the housing itself is more expensive, but it’s made more affordable with some type of subsidy. And I’m generally against that. The only reason, as I said, I’m in favor of LIFT Home (the Low-Income First-Time Homebuyer assistance) is because we’ve designed LIFT Home so that it doesn’t drive up the house price. It puts the money in the pocket of the consumer through wealth building. That is completely 180 degrees different than every other housing assistance program the federal government has undertaken in the last 50 years. That’s what distinguishes it from everything else. So, this cookie jar would be a way to continue these types of programs that end up driving up prices. Ultimately, you know, the utility concept sounds pretty benign — we have electric utilities and we have water utilities, but those are all local.

We don’t have a national utility for the entire country. We don’t even have an example of how that has worked. So, the idea that you would take Fannie and Freddie, which are joined at the hip already, and almost operate as one entity, even though they’re two separate entities that you would actually formally make them into one utility. To me, this is a concept that is so beyond the pale that I can’t even imagine people thinking of it, except that if you’re in the government mortgage complex and everything that increases the government support for housing is good, then, of course, you’re in favor of the utility. So that’s why you have the NAR and that’s why you have these other groups that you mentioned and former Fannie Mae executives or Freddie Mac executives, that’s why you have them in favor because they are fundamentally in favor of government involvement in the housing market.

But, it’s the government involvement in the housing market has created the problem. I’ve often said the problems we have in housing aren’t in spite of what the government has done in the housing area. It’s because of what the government has done in the housing area. Every area of the economy that doesn’t have this tremendous intrusion by the government is in much better shape. Computers, motels, hotels, cars, you name it … What are the parts of the economy that have problems? Well, health care with huge amounts of government involvement; housing, which also has vast amounts of government involvement; and higher education with vast amounts of government involvement; and primary and secondary education with vast amounts of government involvement. Those are the places that we have the real problems. They all have one thing in common — vast amounts of government involvement

Willison:

Wouldn’t a public utility commission, let’s say it was controlling, wouldn’t they be able to control the returns that the GSEs have so that it would prevent some of their rent taking? And, actually, isn’t FHFA director Mark Calabria (who stepped down in 2021) somewhat serving as a of a chair of a public utilities commission now?

Pinto:

So, I’ll say two things: First, Mark’s predecessor was Mel Watt and their policies under this exact same statute — and the statute hasn’t changed one iota — are completely different. So, you could have Mark there and get one set of policies, and you could have Mel Watt there and get 180-degree different policies. The multi-family policy is completely different under both directors. The low-down-payment loans by Fannie and Freddie, 3% down was completely different with Mel Watt versus Mark and the DTI policies above 45%, completely different. The risk layering completely different. I could go on and on and on. It’s like they’re in two different worlds with the same statute. So, the statute and what you write doesn’t make any difference. There’s so much room for, you know, maneuvering around.

But to your first point, I remember testimony by I believe it was Treasury Secretary (Timothy) Geithner back 12 years ago. It was probably in 2009. He was asked the question about releasing Fannie and Freddie from conservatorship and whether he’d be willing to reduce — this was before the sweep — reduce the dividend from 10% to 4% or 5%, which had just been done with AIG. I recall Secretary Geitner saying: Fannie and Freddie are fundamentally different than other companies. Fannie and Freddie got so powerful that they stymied Congress from changing their statute until 2008. Remember, all the battles to change the Fannie-Freddie statute require more capital and stuff that raged from the 90s through 2008, three months before they go into conservatorship, Congress finally got it together to pass the HERA (Housing and Economic Recovery Act).

Number two, the President of the United States tried to rein them in. George W. Bush tried to rein them in, and he was unsuccessful. With the Fed, remember when Alan Greenspan was talking about they were too big to fail and that things needed to be done capitalized and stuff, he gave up. He said here you have these ostensibly private companies that were more powerful than Congress, the President of the United States and the Fed. That is dangerous in a democracy, and we can’t let that happen again. I think the utility model would just do that absolutely and totally. That’s why, you know, I am completely and totally against a utility model. I would take what we have today over the utility model, as much as I don’t like what we have today.

Willison:

So, let’s take it to the next step then. What are your recommendations for GSE reform?

Pinto:

My recommendations are unchanged from the many years that I’ve been writing about this. I think the GSEs are way outside of any public purpose that they were originally set up to serve. They do second homes and investor loans to very high-income individuals that aren’t really necessary in the marketplace. They’re not doing anything to help promote first-time homebuyers or homeownership. Yet,  the little steps that director Calabria has taken have raised a firestorm from the government mortgage complex. The government mortgage complex never wants to give up anything that gets given to them. That’s the way these things work. They don’t care whether it’s serving the public interest or not. We don’t want anything taken. We don’t want any of our rent-seeking reduced. Secondly, Fannie and Freddie have become massive refinance machines, and one can say that although refinances are good …  the 30-year mortgage was never designed to be one that got refinanced every couple years.

It destroys the whole concept of building up the equity over time. Instead, people refinance the loans. Yes, the house price may have gone up in value some but they refinance, and then they go back to a 30-year mortgage, go from 27 back to 30, and then you start the whole cycle over again. And I think that’s in large measure because most of the business GSEs do historically, and in the last year or two to three years has been in the refinance area, cash-out refinances. Again, there’s no justification for Fannie and Freddie being involved in the cash-out business. The private sector can handle that business. So, you’re left with probably what’s about a third of their business being purchase business that’s not involved with investors and second homes.

And that business also has got home-price limits or mortgage limits of whatever, $600,000. You put a down payment on that at that level, and you’re talking about a $750,000 house with a 20% down. And that’s not in California. That’s in the rest of the country. So again, we’ve suggested that you could start reducing the impact. This is how you get these house prices somewhat under control if you provide this financing, easy financing that Fannie and Freddie are providing every day, every month all throughout the year. That’s one thing that the mortgage industry loves, is that Fannie-Freddie provide liquidity 24/7. Well, when you provide liquidity 24/7, you can’t adjust during market ups and downs. So, it is just always on. It’s like FHA has become, we need to be procyclical during the boom, but we also need to be procyclical countercyclical during the bust.

Wait a minute, that means you’re always pushing against whatever’s going on during boom times. You’re pushing higher, and during bust times, you’re trying to bring it up. That doesn’t make sense. If the government’s supposed to have a role, it should be during the bust times. That’s how it originally started back in for both Fannie and FHA back in the 30s. But, of course, once these programs get started, it’s very hard to roll them back. So, I would just sort of bring Fannie down. We don’t need all of these agencies. We don’t need an FHA, FHFA, Rural Housing, a Fannie Mae, a Freddie Mac and 11 Federal Home Loan Banks. We have a plethora of alphabet soup. We’ve got Ginnie Mae. We’ve got all of these different things, and all of them serve one purpose. This isn’t the stated purpose, but this is what actually happens. Let’s drive up prices. You want to know why we have higher prices? It’s because we keep ginning up demand and we don’t have enough supply … Economics 101 tells us prices are what have to change and they go up.

Willison:

Ed, thanks for providing a view that we really don’t often hear among Housers. And and I appreciate you taking the time with me today.

Pinto:

And I’m a Houser from way back, by the way.

Willison:

Before we end I was rummaging through a drawer literally this past weekend and I came across this little pamphlet, and your name immediately came to my mind. I remember you handing it to me at an AEI forum. What’s the story behind this pamphlet?

Pinto:

So, the story is that when FHA was stood up in the legislation passed in 1934 … FHA stood up in 1935. There were people working in housing and thinking about housing and most of were the progressives of the day. And they stayed in housing for decades afterwards. And they really thought, well, they were very thoughtful, you know, the stain, of course, is what they did with segregation and discrimination and all of that. But they were very thoughtful about how do you actually get people in homes? And they realized that you’ve got people in homes by giving them this concept of if you have a 10- or 1-5 or 20-year term that you’ll be paying enough each month in amortization, that it’s like buying the home and renting it yourself.

I think that phrase is in that pamphlet. They also understood that FHA had a particular provision that I think went back to 1930s, which said you can’t take cash out for any purpose. You can only take cash out if you’re going to put it back in the house. Otherwise, the house becomes — they didn’t use this term — it becomes an ATM. FHA’s underwriting rules back in the Thirties, Forties and Fifties prohibited that explicitly. They also, the concept of refinancing rate and term every, you know, six months was a foreign concept to them. First of all, interest rates were much more stable than they have been in the last 30 or 40 years. So, they just had an approach that said, “Look if you want to get people into homes, here’s the way you do it.” They started with that.

We have the approach that is how do we make the most money available to the housing finance system, and the players in the system are going to do great, but it’s not going to be, and the people who already own a home or get on that ladder early, they’re going to do great, but the people coming next, the people we really should care about as an industry, they get left out. And the people who’ve been left out for generations, including Black people and to a more recent extent, Hispanics. Those are the people who’ve gotten left out, and that’s why they’ve gotten left out. We need to change policies so that everyone has a chance  to get on this ladder, but it has to be a ladder to wealth building, not a ladder to disaster. I think there’s another phrase in that pamphlet that talks about if you have the wrong loan terms, then it’s just a recipe for disaster.

And so again, FHA and the people that stood this up, stood it up, knew that they came out with it with these principles. However, unfortunately, there was also the stain of the discrimination that they also supported. But that, unfortunately, that was the way the entire economy and government was at the time. So, we have to look at the good part and not throw everything out because they had, this part that was the stain. So, there are good things to learn here and wealth building, how to build wealth is what I’ve taken away from the enlarged mission of what FHA did.

Willison:

Well, I really appreciate you walking through this history of housing finance with us and the type of things that we can learn from the past to promote good things in the future. Thanks for taking the time.

Pinto:

Thank you, Kirk. This is a great pleasure. I really appreciate it.