Will Wall Street steal away Fan­nie, Fred­die?

The Washington Post Sunday - - BUSINESS - STEVEN PEARL­STEIN

What’s to be done with Fan­nieMae and Fred­die Mac? Right now, a cot­tage in­dus­try of an­a­lysts, lob­by­ists, reg­u­la­tors, fi­nanciers and elected of­fi­cials is hard at work for­mu­lat­ing a fu­ture course for the mort­gage fi­nance giants, which have been un­der govern­ment con­ser­va­tor­ship since Septem­ber 2008. White pa­pers are now spew­ing from think tanks and trade as­so­ci­a­tions, and the Trea­sury is set to is­sue its rec­om­men­da­tions early next month, to be fol­lowed by a round of con­gres­sional hear­ings.

This is likely to be­come a noisy, ide­o­log­i­cal de­bate that reignites the old ar­gu­ment about whether Wall Street greed or Washington med­dling is to blame for the fi­nan­cial cri­sis.

Most of the shout­ing is likely to come from free-mar­ket ide­o­logues, in­clud­ing the House Repub­li­can lead­er­ship, which is de­ter­mined to get the govern­ment out of the busi­ness of pro­vid­ing mort­gage guar­an­tees and sell Fan­nie and Fred­die off in pieces.

These lead­ers will be op­posed by a for­mi­da­ble coali­tion of home builders and com­mu­nity bankers, along with low-in­come-hous­ing ad­vo­cates and the Obama ad­min­is­tra­tion. Their view is that with­out some form of govern­ment guar­an­tees, loan rates will rise, hous­ing prices will

fall and the 30-year fixed mort­gage will dis­ap­pear.

What­ever is de­cided will have sig­nif­i­cant im­pact on the na­tional hous­ing mar­ket and the econ­omy. But for those of you read­ing this col­umn on paper, the much big­ger im­pact could be on the econ­omy of the Washington re­gion where you live. Fan and Fred are among the largest pri­vate em­ploy­ers and the pil­lars of a much larger hous­ing fi­nance clus­ter that ac­counts for tens of thou­sands of high-pay­ing jobs. They have helped to make Washington the cap­i­tal of the sec­ondary mort­gage mar­ket and a grow­ing cen­ter for bank­ing, fi­nance and as­set man­age­ment. If the con­ser­va­tive ide­o­logues have their way, this en­gine of the re­gional econ­omy will be dis­man­tled and shipped north to Wall Street.

This is­sue be­longs at the top of the pri­or­ity list for the re­gion’s busi­ness and po­lit­i­cal lead­ers. The loom­ing re­duc­tion in govern­ment spend­ing al­ready casts a me­nac­ing cloud over the area’s econ­omy, and the dis­man­tling of Fan­nie and Fred­die would be a body blow.

On the other hand, if the mort­gage twins were to reemerge as pri­vate com­pa­nies, they would gen­er­ate hun­dreds of mil­lions of dol­lars each year in ad­di­tional rev­enue for the District (Fan) and Vir­ginia (Fred) in the form of cor­po­rate-profit taxes, from which Fan­nie and Fred­die have long been ex­empt un­der their ex­ist­ing fed­eral char­ters. The fis­cal ben­e­fits from lur­ing Northrop Grum­man’s or Hil­ton’s cor­po­rate head­quar­ters look like chump change by com­par­i­son.

In the past, Fan and Fred needed lit­tle help man­ag­ing their po­lit­i­cal risk and get­ting what they wanted from govern­ment. They were so good at it, in fact, that you could ar­gue it led di­rectly to their un­do­ing. Now that they are wards of the Trea­sury, how­ever, it is Fan and Fred who have be­come po­lit­i­cally neutered, dis­cred­ited in the minds of the pub­lic and barred by reg­u­la­tors from par­tic­i­pat­ing in the de­bate about their fu­ture. And you can be sure that Wells Fargo, Bank of Amer­ica and the other big mort­gage orig­i­na­tors will spare no ex­pense not only to pre­serve a sec­ondary mar­ket in govern­ment-guar­an­teed mort­gages but also to en­sure that it is they— and not suc­ces­sors to

Loom­ing re­duc­tions in govern­ment spend­ing al­ready cast a cloud over the area’s econ­omy, and the dis­man­tling of Fan­nie Mae and Fred­die Mac would be a body blow.

Fan and Fred— that dom­i­nate it and cap­ture most of its prof­its.

As Bethany McLean and Joe No­cera lay out in “All the Devils Are Here,” their ex­cel­lent his­tory of the fi­nan­cial cri­sis, Wall Street has been try­ing to kill off Fan and Fred for 30 years, ever since Lew Ranieri of Salomon Bros. and David Maxwell of Fan­nieMae pi­o­neered the idea of com­bin­ing mort­gages into pack­ages that are sliced and diced and sold as bonds to pen­sion funds and Ger­man den­tists. While Fan and Fred dom­i­nated the mar­ket for fixed-rate prime mort­gages that car­ried a govern­ment guar­an­tee, the Wall Street firms built up boom­ing busi­nesses cre­at­ing and trad­ing “pri­vate la­bel” se­cu­ri­ties backed by vari­able-rate loans, jumbo mort­gages and loans to bor­row­ers with sub­prime credit rat­ings. In the end, it was Fan and Fred’s des­per­ate at­tempt to grab a share of this riskier and more lu­cra­tive mar­ket that led to their un­do­ing and fur­ther in­flated the sub­prime bub­ble. Now that the bub­ble has burst and the “non-con­form­ing” mar­ket has all but dis­ap­peared, the banks have again set their sights on Fan and Fred.

As the de­bate un­folds, here’s how things are likely to play out.

One role Fan and Fred have pro­vided— in­deed, the orig­i­nal rea­son for their ex­is­tence— was to act as the buyer of last re­sort for mort­gages when banks and pri­vate in­vestors re­treat, herd­like, from the mar­ket, which hap­pens with some reg­u­lar­ity. In the fu­ture, that role could be filled by the Fed­eral Home Loan Banks and the Fed­eral Re­serve, as it was dur­ing the most re­cent cri­sis.

Fan and Fred, alas, weren’t just buy­ers of last re­sort— they also bought ag­gres­sively when ev­ery­one else was buy­ing, be­cause it was an easy way to in­crease prof­its. In the fu­ture, their port­fo­lio of mort­gages and mort­gage-backed se­cu­ri­ties will be grad­u­ally sold off, al­low­ing the Trea­sury to re­coup some, or per­haps all, of the cost of the govern­ment’s res­cue.

That still leaves the ques­tion of who will be in the busi­ness of pack­ag­ing and se­cu­ri­tiz­ing mort­gages. Most of the pro­pos­als en­vi­sion a limited num­ber of pri­vate, fed­er­ally reg­u­lated firms that would be re­quired to hold sig­nif­i­cant amounts of cap­i­tal to cover losses from loan de­faults that might re­sult from a rou­tine down­turn in the econ­omy or hous­ing mar­ket. The big de­bate is over the ex­tent of any govern­ment guar­an­tees, or rein­sur­ance, of ex­tra­or­di­nary losses if and when the cap­i­tal of the is­su­ing firms is de­pleted.

Two other is­sues, how­ever, are of vi­tal in­ter­est for the Washington econ­omy.

One is whether Fan and Fred will be liq­ui­dated, their valu­able soft­ware and data­bases and cus­tomer re­la­tion­ships sold to Wall Street vul­tures, or whether the ex­ist­ing en­ter­prises will be able to raise new cap­i­tal, find new names and emerge as two of the char­tered play­ers in the new sec­ondary mar­ket.

The other ques­tion is whether the big banks that al­ready have big busi­nesses orig­i­nat­ing mort­gages will also be al­lowed to vie for one of the se­cu­ri­ti­za­tion char­ters.

If they are, it’s a sure bet that the big banks will clev­erly use their pres­ence in both mar­kets to grad­u­ally drive out com­peti­tors in both the sec­ondary mar­ket— in­clud­ing Fan and Fred— as well as in the loan orig­i­na­tion busi­ness, which is of par­tic­u­lar con­cern to re­gional and com­mu­nity banks.

In Congress, two Repub­li­can House mem­bers from Vir­ginia will be key play­ers in this fight: Ma­jor­ity Leader Eric Can­tor and Robert Hurt, vice chair­man of the sub­com­mit­tee with ju­ris­dic­tion over Fan and Fred. Vir­gini­ans might want to ask them why they want to rob their state of jobs and hun­dreds of mil­lions of dol­lars in an­nual tax rev­enue and ship them up to Wall Street.

In the mean­time, the Washington busi­ness com­mu­nity might want to rally be­hind other ideas for re­struc­tur­ing the mort­gage fi­nance mar­ket, lest Repub­li­cans suc­ceed in un­nec­es­sar­ily de­stroy­ing two of the re­gion’s most valu­able en­ter­prises.

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