Barney Frank’s Plan: Fannie and Freddie as Government Profit Machines

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In 2008, at the height of the turmoil in the housing and financial markets, the federal government took over Fannie Mae and Freddie Mac, the two government sponsored enterprises (GSEs) that guarantee half of all home mortgages in the United States.ⁱ That’s hardly news to anyone. The GSEs’ vast holdings of low quality mortgages plunged them into insolvency in 2008, threatening to bring down the entire financial system. Likewise, it’s well established that the U.S. Treasury has pumped roughly $148 billion into the two GSEs to keep them solvent and maintain their securitization and guarantee businesses. Just yesterday, the Federal Home Loan Finance Agency (FHFA) released updated projections that show taxpayers will end up paying even more. The agency says Treasury payments to the GSEs will ultimately cost taxpayers between $221 billion and $363 billion (for a full breakdown, see this other e21 post).

Imagine then how ridiculous it would be if someone argued that Fannie and Freddie are actually booming profit centers – and that taxpayers stand to make billions of dollars every year that the failed GSEs guarantee home mortgages while under government control. It looks like Rep. Barney Frank (D-MA), the chairman of the House Financial Services Committee and a notorious champion of the mortgage GSEs, is quietly preparing to make just such a case when GSE reform takes center stage early next year.

Congressman Frank sent a letter to the Congressional Budget Office (CBO) this spring asking that the agency provide him with an alternative, unofficial estimate of GSEs’ cost to the government. Ever since the government took control of the two entities, the CBO has accounted for the GSEs’ liabilities as direct loan and loan guarantee programs – and reported the costs in the official baseline budget. Now, with the blessing of the congressional budget committees, CBO has started to measure the GSEs’ budgetary impact using fair-value estimates, like those used in the private sector and which capture the full risks taxpayers bear.

Why is this important? Normally, budget scorekeepers analyze government loan programs using accounting rules that were established under the 1990 Federal Credit Reform Act (FCRA). But a flaw in those rules makes it impossible for analysts to account for the full risks inherent in the loans. (See e21 commentary “Credit Reform Act: Another Budget Loophole” for a full explanation.) Last month, the CBO made public a letter it sent to Rep. Frank explaining that using fair-value methodology for the GSEs instead of FCRA accounting “provide[s] Congress with the most accurate information about the cost of supporting those entities [unlike FCRA]… because it recognizes that there is a cost to taxpayers when the government assumes financial risk.”

Not surprisingly, it turns out that Congressman Frank isn’t a fan of the fair-value approach that the CBO deems more accurate. His original letter asked CBO to run the numbers instead under the old Credit Reform Act accounting rules. Of course, lawmakers don’t ask scorekeepers for alternative cost estimates unless they have an agenda. That’s why it’s no surprise (considering Rep. Frank’s historic support for the GSE model) that he favors the flawed FCRA accounting regime, which cast Fannie and Freddie’s liabilities in a more favorable light compared to fair-value estimates. So favorable in fact that the mortgages held or guaranteed by the two agencies appear to turn a profit for the government when applying the FCRA rules.

According to CBO’s response to Rep. Frank, the two GSEs’ activities will earn $44 billion for the government over the next ten years under FCRA accounting. Compare that to the official fair-value estimate showing a cost to taxpayers of $53 billion over the same time period. All in all, there is a $97 billion difference between the official estimate and the figure Rep. Frank requested.

Thankfully, the CBO is careful to emphasize in its response to Rep. Frank that the earnings shown under FCRA accounting aren’t real. It’s almost as if the agency wanted to stamp a disclaimer on its response that reads, “Warning: Do Not Use This Estimate”. After all, how can the government subsidize homeowners and lenders with low interest rates and fees, then underwrite the default risk on trillions of dollars of these mortgages, and turn a profit for taxpayers? This free-lunch illusion is only possible under FCRA because its accounting rules don’t measure all of the risk that taxpayers are taking on through the GSEs’ mortgage guarantees. It is this flaw the CBO tells Rep. Frank that makes Fannie and Freddie’s loan programs “appear less costly than comparable activity undertaken in the private sector even if the government is not intrinsically more efficient at the activity being analyzed.” [Emphasis added]

To read such statements leaves little doubt as to why Rep. Frank made the request for the alternative estimate. The debate over Fannie and Freddie’s future will pit those who want the government-controlled GSEs to continue to monopolize key parts of the mortgage market against advocates who favor a more competitive market that relies on private enterprise. The accounting bias embedded in the FCRA gives Rep. Frank and other advocates of the government monopoly approach a powerful advantage in that debate.

Taxpayers need to know, however, that Fannie and Freddie are no free lunch – even if Rep. Frank asks the CBO to write up an estimate that makes it look as if they are. The failed GSEs have already cost taxpayers dearly in part because lawmakers hid the risks and obligations that these entities posed to the government (and to the taxpayer).

Misleading budgeting (i.e. the GSEs’ off-budget treatment and implicit government backing) ultimately imposed huge costs on taxpayers and nearly brought down the entire financial system. Unfortunately, it looks like Rep. Frank hasn’t learned that lesson. Hopefully his colleagues have. As a first step in reforming the GSEs, Republicans and Democrats should agree that no matter how these entities are restructured, Congress and the White House will fully account for the costs and risks of the government’s role in the mortgage market – and that means using fair-value estimates for Fannie and Freddie, not Congressman Barney Frank’s “special request” to the Congressional Budget Office.

Notes

[i] Since the collapse of the private mortgage market in 2008, the federal government has supported nearly all mortgage lending in the U.S. through control of the GSEs or through the Federal Housing Administration (FHA).

Jason Delisle is the Director of the Federal Education Budget Project at the New America Foundation.