Timothy Geithner, the current Secretary of the Treasury, pledged at a recent congressional hearing to reform the way Fannie Mae and Freddie Mac operate. Geithner thought Fannie and Freddie had been more prudent than the private market mortgage lenders but acknowledged mistakes. He said the failure of Fannie and Freddie in 2008 was part of a broader crisis and revealed structural flaws in the entire housing finance system. The main flaws were seen to be insufficient regulation and enforcement of existing rules and regulations.
The Vice President and Liaison to Government Affairs of the National Association of Realtors, Vince Malta, mostly agreed with Geithner. Malta thought the basic structure of Fannie Mae and Freddie Mac were flawed. He saw them having a private profit structure but a public loss structure, putting money in the pockets of those in charge but taxpayers on the hook for losses. Instead, the entities should be self-sufficient and price risk effectively to cover potential losses. Any profit should be used first to establish capital reserves.
Fannie and Freddie were allowed to earn private gains for many years while at the same time being subsidized by taxpayers. Federally regulated banks are required to hold 4% capital against mortgages on the balance sheets. Fannie Mae and Freddie Mac were only required to hold 2.5 percent capital against held mortgages and only 0.45% against guaranteed mortgage derivatives. They made unwise risk decisions during the boom years by investing heavily in mortgage derivatives.
The Federal Home Loan Bank system also made unwise decisions. Heavy investment in sub-prime mortgage securities was part of their game plan as well. These risk decisions and lack of capital reserves to cover loans and securities gone bad are a large part of the present problem.
Everyone involved thinks the government needs to stay involved in the home lending industry. Federal government loan guarantees are seen as the only way out of the housing mess. Without some sort of government guarantees the private mortgage industry would shrink to the point of uselessness. The question is: how will things be restructured and will that really solve the problems that were exposed during the past few years?