There is hope, slim though it may be, that financial reform will actually reduce the chances of another housing market meltdown. GOP Senators John McCain, Richard Shelby and Judd Gregg introduced a reform amendment that addresses the risks posed by Fannie Mae and Freddie Mac. Let's see what the Democrats do about it.
The Financial Crisis Inquiry Commission spent yesterday focusing on financial "leverage," using Bear Stearns as an example. But Fannie and Freddie were twice as leveraged as Bear, and much larger as a share of the mortgage market. Fan and Fred owned or guaranteed $5 trillion in mortgages and mortgage-backed securities when they collapsed in September 2008. Reforming the financial system without fixing Fannie and Freddie is like declaring a war on terror and ignoring al Qaeda.
According to the Wall Street Journal Freddie Mac lost $8 billion in the first quarter of this year. Fannie and Freddie lost a combined $126.9 through the end of 2009. This makes them bigger losers in the financial crisis than even AIG and Citigroup – so big in fact that the Obama administration won't include their losses in the federal budget because of the impact on the deficit.
It's not as if the administration isn't aware that there's a problem. Last Christmas Eve it raised the $400 billion cap on Fannie's and Freddie's potential taxpayer losses, giving the two a virtual blank check. That doesn't imply that Democrats have any plans to rein them in, so the GOP amendment offers a glimmer of hope.
The virtue of Mr. McCain's amendment is that it will give Senators a chance to vote on the kind of reform that Congress blocked for so long, notably with Senator Barack Obama helping the blockade. The amendment mandates that the current government conservatorship of Fan and Fred will end within 30 months. In the meantime, the companies will have to reduce their mortgage portfolios by 10% each year. If the terrible twosome can't stand on their own after conservatorship, they would then go into receivership and be liquidated.
If they can survive on their own, they would have three years before the expiration of their federal charters, during which time they would have new operating restrictions. Messrs. McCain, Shelby and Gregg would repeal the affordable housing goals previously legislated for Fan and Fred and which contributed to their terrible mortgage bets, and the companies would have to reduce the mortgage assets held on their books by nearly 50% within two years and raise their capital standards.
Fannie and Freddie would also have to start paying state and local sales taxes, lose their exemption from full registration at the Securities and Exchange Commission when they issue securities, and start paying fees to repay the taxpayer for the value of federal guarantees. The $400 billion limit on taxpayer assistance would be reinstated, and for as long as they are in federal conservatorship or receivership, they would have to be included in the federal budget.
In short, the McCain amendment precisely targets the problems that caused the mortgage crisis: If the housing giants are no longer subsidized, they will become small enough to fail. That means they will stop lending money to people who cannot afford to pay them back, and in turn they will stop endangering taxpayers.
I'll be shocked if Democrats actually go along with it. Their talk of ending bailouts is just that - talk. It's not certain that Senate Majority Leader Harry Reid will even allow a vote on the amendment. For Democrats reform is really about giving politicians greater control over financial companies – and the contributions that flow from them.
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