If you’re like me (before I read this article), you barely know what Fannie Mae and Freddie Mac do, let alone how they came to be or why no one seems to be able to find a replacement for them. That’s reason enough to read our feature in the March/April/May issue of the Washington Monthly. The piece is an adaptation of Bethany McLean’s 2015 book: Shaky Ground: The Strange Saga of the U.S. Mortgage Giants.

You’ll come away educated, that’s for sure. To give you an idea of why President Obama hasn’t been able to get his wish that “private lending should be the backbone of the housing market…with a limited government role,” just consider the following:

One of the narratives, which is appealing to those on the right, is that we can get the government out of the housing market with the flip of a switch. In 2013, Jeb Hensarling, the Tea Party Republican representative from Texas, authored a bill that would kill the GSEs and, with the exception of some support for very low-income housing, not replace them with anything. While no one knows for sure what would happen—Fannie Mae has been around since the 1930s, after all—most analysts and market participants agree that the downside is that a great swath of the middle and lower classes probably would get five- to fifteen-year mortgages with floating rates, rates that would vary significantly depending on income and geography. Homes would be less affordable, so housing prices would likely fall. Consider that with interest rates at 3.75 percent, a $200,000 home with a 20 percent down payment and a ten-year fixed-rate mortgage on the remaining $160,000 would have a monthly payment of $1,521. With a thirty-year fixed-rate mortgage, the monthly payment is $752. Mortgage capital might be hard to come by in times of stress. Under the new system, not much would change for wealthy borrowers, but the effect on lower- and middle-income Americans could be significant.

McLean does have a recommendation that she feels is superior to just killing Fannie Mae and Freddie Mac and letting the cards fall where they may.

The best idea, whose most prominent backer is Graham Fisher’s Josh Rosner, is that the GSEs would operate as utilities, much like your electric utility, with a cap on the return they are allowed to earn, and regulated as such by a competent regulator with real teeth. The regulator, as Rosner writes, would “ensure that the firms employ their benefits of scale to minimize the costs to end-users while allowing them to earn acceptable, rather than excessive, rates of return.” They would be somewhat like the GSEs were in the 1980s, before all public companies faced inordinate pressure to grow their earnings and please investors. They would be well capitalized at a level consistent with that of other large financial firms, and they would no longer be able to hold mortgage securities on their own balance sheet. (Their portfolios of such securities have already shrunk dramatically.)

Rosner also writes that it is important that the GSEs serve as “countercyclical providers of liquidity.” What he means is that if the market is going crazy, and Wall Street is happily providing mortgage capital, the GSEs can and should stand back. That way, they will have dry firepowder if there are problems, and private capital flees the market. There’s already a taste of how that might work. Today, the GSEs are selling a portion of the risk they insure to other investors. The current way the GSEs sell risk is not without its flaws, but it is a start to doing exactly what President Obama said he wanted, which is getting private capital in front of the government.

Considering the systemic risk poised by Fannie Mae and Freddie Mac (a current capital ratio of 0.1%), it’s not a good idea to do nothing. And, as McLean argues, in deciding what to do “Americans’ best interests have rarely dictated the answer, precisely because too few people care.”

Of course, in order to care, we have to at least have some understanding of the issues. That’s why you should devote some time to reading the whole piece.

Martin Longman

Martin Longman is the web editor for the Washington Monthly. See all his writing at ProgressPond.com