Fannie Freddie Common Security: Even Bigger?

Chidem Kurdas

Housing finance giants Fannie Mae and Freddie Mac long had their own specialized regulators, as befits government-created and currently government-controlled entities.

These regulators vie with the U.S. Securities and Exchange Commission in their glowing failure to do what they were supposed to do in the years leading up to the 2008 financial crisis. The SEC did not protect investors – see my new book, Ponzi Regulation – and the housing regulators did not keep Fannie and Freddie solvent, let alone moderate the bubbling property market.

But bureaucracies are notorious for finding new rationales and justifications for themselves after failing to fulfill their function. Since the crisis, the regulators have been “conservators” with Fannie and Freddie as their wards.

That’s the background for a speech given today at the Brookings Institution by Melvin Watt, director of the Federal Housing Finance Agency—a cosmetically altered version of the old regulatory body. Mr. Watt, who started the job in January, presented the highlights of the FHFA 2014 plan for Fannie and Freddie.

Press reports focused on the planned expanding role for Fannie and Freddie in housing finance, despite the expectation that they were to shrink, given as they turned out to be risk factor in themselves in the property boom-bust cycle.

But there’s a more perplexing item in Mr. Watt’s prepared text. The two agencies are building a common platform for securitizing single-family mortgages—that is, for combining large numbers of single-family mortgages bought from lenders and slicing & dicing the aggregate into securities.

Issuing mortgage-backed securities is the agencies’ core activity, but until now they did this separately. The goal is to create a “joint venture owned by Fannie Mae and Freddie Mac that operates one system with updated technology,” according to Mr. Watt.

But housing finance, and the agencies in particular, were to be reformed so as to prevent bubble and collapse scenarios. Mr. Watt acknowledged that building a common securitization platform for “a future housing finance reform system that is not yet defined is extremely risky and could add needless costs.”

He claims the system will include software and standards from the private sector where possible so that private parties can use it as well as the agencies, depending on the future shape of housing finance.

But why build this platform now, when everything is still seemingly up in the air?

The plan is to move toward a single common security based on the platform. Mr. Watt said they believe this will improve liquidity in housing finance and also reduce costs to the agencies, particularly to the relatively smaller Freddie Mac whose securities have traded at a discount to Fannie Mae’s.

For this purpose, FHFA and its gigantic wards are to define the common single security’s “parameters along with shared contractual and disclosure requirements.” The project is expected to take years.

It sounds like the plan is to eventually merge Fannie and Freddie.

The single security issuer would be so immense as to boggle the mind. What’s planned is a change from too-big-to-fail to even-bigger. Yet there is no word about comprehensive reform.

Maybe the ultimate aim is something else, but we have not been told.

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